The health care reform legislation that President Obama signed into law in March, 2010 contains sweeping changes that affect all those involved in the health care system: individuals, providers, insurers and not the least of all, employers. The legislation consists of two separate laws — the Patient Protection and Affordable Care Act (“PPACA”) and the Health Care and Education Reconciliation Act of 2010 (“HCERA;” collectively, PPACA and HCERA will be referred to herein as the “Act”). The Act includes dozens of provisions that will significantly affect the role of the employer in providing health coverage to employees.

I. “Pay or Play” Mandate

The provision of the Act garnering the most attention is the so-called “pay or play” mandate, which requires many employers to provide health insurance to their employees effective January 1, 2014, or pay a penalty.[1]

The “pay or play” mandate applies to “large employers,” which means an employer that employed an average of at least 50 full-time employees during the preceding calendar year. For the purposes of the mandate, all employees of employers under common control are counted and an employee working at least 30 hours per week is considered full-time.[2] Part-time employees must be converted to full-time equivalents to determine whether the 50 employee threshold is met.[3] In addition, there are special rules for employers that hire seasonal employees.[4]

In 2014, a large employer must offer minimum essential coverage that is affordable to employees in order to avoid the penalty. To qualify as affordable, the employee’s required contribution for the coverage must not exceed 9.5% of the employee’s household income. The coverage must also provide a “minimum value” to the employee — that is, the health plan must pay at least 60% of the plan’s total costs.[5]

Large employers who contribute to the cost of minimum essential coverage under the employer’s plan must also provide “free choice vouchers” to certain employees. The employees who must be offered free choice vouchers are those employees whose household income does not exceed 400% of the poverty line (which for 2010 is $88,200 for a family of four[6]), and for whom the required contribution for coverage is between 8% and 9.8% of household income. The free choice vouchers will be in an amount equal to the amount paid by the employer for coverage under the employer plan for which the employer subsidy is the largest (as adjusted for age and enrollment category). Employees will be able to use these free choice vouchers to purchase health plan coverage from a state health exchange (described below under the heading “Changes Effective for January 1, 2014 or Later”).[7]

Large employers who do not offer minimum essential coverage under an employer plan will be penalized $2,000 annually for each full-time employee (excluding the first 30), if the employer has at least one full-time employee enrolled in a qualified health plan under a state health exchange. If the employer offers minimum essential coverage under an employer plan, and still has employees enrolled in a qualified health plan under a state health exchange, the penalty is $3,000 annually for each employee that enrolls in a qualified health plan and is provided a premium subsidy or reduced cost sharing. The employees who qualify for a premium subsidy and reduced cost sharing are those employees who must contribute more than 9.5% of their household income to receive coverage under their employer’s plan or whose employer’s plan does not cover at least 60% of the costs of the benefits provided by the plan. No penalty is payable with respect to an employee for whom the employer provides a free choice voucher. The Act requires that penalties be paid on a monthly basis. The employer may not deduct penalties.

II. Changes That Impact Group Health Plans

The Act requires that all group health plans, whether fully insured or self-insured, be significantly changed over the next four years, except that collectively bargained plans may have a later effective date.[8]   The Act provides some relief for “grandfathered plans” — that is, group health plans in which an individual was enrolled on March 23, 2010.[9]   Employers who want to take advantage of the grandfathered status of their group health plans need to be cautious in making any changes to these plans. If possible, employers should wait until the federal government issues guidance on what changes to a plan causes it to lose its grandfathered status. Once a plan loses its grandfathered status, it will become subject to the additional requirements that apply to non-grandfathered plans.[10]

The following is a summary of the major changes in effect for health plans, beginning as early as June, 2010. For each health plan change discussed below, we have noted whether the change applies to grandfathered plans.

Changes Effective for Plan Years Beginning on or after September 23, 2010 or Earlier

Early Retiree Reinsurance Program. Beginning in June 2010, an early retiree reinsurance program will be established to encourage employment-based health plans that provide benefits to eligible early retirees. An eligible early retiree is a retired employee who is age 55 or older and not eligible for Medicare. This program will be funded by the federal government (up to $5 billion) and will reimburse an eligible health plan for 80% of the claims of an eligible early retiree in a plan year that exceed $15,000 but do not exceed $90,000 (that is, the maximum reimbursement is $60,000).[11] In order to be entitled to the reimbursement, the health plan must comply with the Act and with rules established by the Department of Health and Human Services (“HHS”). An employer interested in this program should apply as soon as possible, because applications will not be accepted once it is anticipated that the $5 billion pool available for the program will be exhausted by the health plans that have already filed applications.[12]  

Children’s pre-existing conditions. Effective for plan years beginning on or after September 23, 2010, the Act prohibits all group health plans, including grandfathered plans, from having pre-existing condition exclusions for children age 18 or under.[13]

Dependent coverage. Plans, including grandfathered plans, must provide dependent coverage for children age 25 or younger for plan years beginning on or after September 23, 2010. Prior to January 1, 2014, a grandfathered plan does not need to provide coverage to an adult child if that child is eligible to enroll in another employer-sponsored group health plan.[14]

The Act also expands the ability of an employer to provide tax-free health insurance coverage to children of employees. Effective March 30, 2010, coverage provided to a child who is age 26 or younger is not subject to tax even if the child does not otherwise meet the requirements to be a dependent for tax purposes.[15]

Lifetime and annual limits prohibited. Effective for plan years beginning on or after September 23, 2010, lifetime and annual limits on the dollar value of benefits provided under a plan will not be permitted for any benefits that are “essential health benefits.” Essential health benefits include ambulatory services, emergency services, hospitalization, maternity and newborn care, mental health services, substance use disorder services, behavioral health treatment, prescription drug coverage, rehabilitative and habilitative services and devices, laboratory services, preventive care and wellness screenings, chronic disease management, and pediatric services.[16] HHS may, in its discretion, provide exceptions to the annual limit rule prior to January 1, 2014. This prohibition will affect all plans, including grandfathered plans.[17] 

The prohibition of lifetime and annual limits will have its greatest impact on so-called “mini-med” plans, which provide coverage to employees up to a designated annual limit (e.g., $25,000). These limits will no longer be permitted, unless HHS provides relief for plan years beginning prior to January 1, 2014.

New coverage rescission requirements. The Act prescribes that plans may rescind coverage only for fraud or intentional misrepresentation of material fact, effective for plan years beginning on or after September 23, 2010. A plan will need to provide prior notice of any such rescission. The rescission rules apply to all plans, including grandfathered plans. Note that many insurers have voluntarily suspended this practice since the Act’s passage, far in advance of the fall deadline.[18]

Non-discrimination requirements. Effective for plan years beginning on or after September 23, 2010, the Act requires non-grandfathered insured plans to meet the non-discrimination requirements that currently apply to self-insured plans. This change will prohibit employers from establishing insured plans available only to executives or other highly-compensated employees.[19]

External review of denied claims. Non-grandfathered plans will be required to develop a system for external review of denied claims for plan years beginning on or after September 23, 2010.[20]

Coverage of preventive services. Non-grandfathered plans will be required to cover certain preventive health services with no cost-sharing requirements for plan years beginning on or after September 23, 2010. Preventive services include services recommended by the United States Preventive Services Task Force, such as certain immunizations and mammograms.[21]

Other Patient Protections. Effective for plan years beginning on or after September 23, 2010, the Act requires that non-grandfathered plans:   (i) permit individuals the right to designate a primary care provider, (ii) cover emergency services at in-network cost-sharing levels, without prior authorization, and (iii) not require an authorization or referral for OB-GYN services.[22]

Changes Effective for Plan Years Beginning on or after January 1, 2011

HSA, Archer MSA penalty increased. Current law generally prescribes a 10% penalty for any distribution from a health savings account (“HSA”) for an item other than a qualified medical expense. This penalty will be increased to 20% effective January 1, 2011. At the same time, the comparable penalty for distributions from an Archer Medical Savings Account (“Archer MSA”) will be raised from 15% to 20%.[23]

Limits on reimbursement for over-the-counter drugs. Also effective January 1, 2011, costs for purchasing most over-the-counter drugs may not be reimbursed through a health flexible spending account (“FSA”) or health reimbursement arrangement (“HRA”) or on a tax-free basis through an HSA or Archer MSA. Costs for insulin and for prescribed drugs – even if those drugs would be available over-the-counter – may continue to be reimbursed through a health FSA or HRA or on a tax-free basis through an HSA or Archer MSA.[24]

Availability of simple cafeteria plan for small employers. Small employers will have the opportunity to adopt a simple cafeteria plan, which will be deemed to satisfy nondiscrimination requirements without the need to satisfy complex numerical tests, starting January 1, 2011. To be eligible to adopt a small cafeteria plan, an employer must generally have an average of 100 or fewer employees during either of the two preceding years. A growing employer can generally continue to sponsor a simple cafeteria plan until it employs an average of 200 or more employees.

An employer sponsoring a simple cafeteria plan must generally permit all employees with at least 1,000 hours of service in the prior year to participate and elect any benefit available under the plan. The employer may, however, exclude employees who have not attained age 21 with one year of service and those covered under a collective bargaining agreement. The employer must also make an annual contribution on behalf of each participant equal to either a uniform level (at least 2%) of compensation or an amount not less than the lesser of (i) 6% of compensation, or (ii) twice the participant’s salary reduction contribution.[25]

Changes Effective for January 1, 2013

Health FSA Contribution Limitations. Beginning on January 1, 2013, contributions to a health FSA will be limited to $2,500 per year (indexed for inflation). The limitation does not include any amount an employer may contribute to an employee’s health FSA.[26]

Retiree Prescription Drug Programs. Effective January 1, 2013, sponsors of retiree prescription drug plans will no longer be able to deduct from income costs covered by drug subsidy payments. This eliminates a double benefit originally intended to provide incentives to lessen the number of retirees switching to Medicare Part D coverage, and may be considered a “material adverse impact” for financial reporting purposes under generally accepted accounting principles or “GAAP.”[27]

Changes Effective for January 1, 2014 or Later

Availability of coverage through state health exchange. As of January 1, 2014, certain small employers will have the opportunity to purchase health insurance coverage for employees through a state health exchange marketplace. Coverage under the exchanges will generally be provided by insurance companies and will need to offer specified coverage levels, limit cost-sharing, and meet numerous other criteria established by the Act or to be established by HHS. In addition, such coverage must include “essential health benefits” (described above under the heading “Changes Effective for Plan Years Beginning on or after September 23, 2010 or Earlier”). Coverage through a state health exchange may be available to employers with 100 or fewer employees, though a state may choose to limit availability to employers with 50 or fewer employees. Certain individuals will also be able to purchase coverage through an exchange beginning on January 1, 2014. [28]

Limited waiting periods. The Act prohibits all plans, including grandfathered plans, from imposing waiting periods of more than 90 days effective for plan years beginning on or after January 1, 2014.[29]

No pre-existing conditions. Effective for plan years beginning on or after January 1, 2014, the Act prohibits all group health plans, including grandfathered plans, from having pre-existing condition exclusions.  [30]

Annual cost-sharing limitations. Non-grandfathered plans must limit annual cost-sharing for plan years beginning on or after January 1, 2014. Such plans may not have a deductible of greater than $2,000 for individual coverage or $4,000 for family coverage (indexed for inflation after 2014). Out-of-pocket limits may not exceed $5,950 for individual coverage or $11,900 for family coverage (indexed for inflation after 2010).[31]

Automatic enrollment. The Act requires employers subject to the Fair Labor Standards Act with more than 200 full-time employees to automatically enroll employees in an employer sponsored health plan (if one exists). Employees must be given notice of the automatic enrollment and must be given the opportunity to opt out of coverage. The effective date of this requirement is unclear and should be clarified by regulations yet to be issued.

III. Other Key Health Care Reform Changes Affecting Employers

Employers will need to do more than revise their health plans to comply with the Act. The following provisions, which take effect anywhere from immediately to 2018, will also have a substantial effect on employers.

Reasonable Breaks and Space for Nursing Mothers. Effective immediately, all employers subject to the Fair Labor Standards Act will be required to provide reasonable unpaid breaks for nursing mothers to express breast milk. These breaks are to be available to nursing mothers for one year after the child’s birth. Employers subject to the Fair Labor Standards Act must also provide reasonable space in which a nursing mother can express breast milk. The space may not be a bathroom and must be shielded from view and intrusion, both by the public and by co-workers. Employers with fewer than 50 employees may be exempt from the space requirement by demonstrating significant hardship due to the employer’s size, financial resources, or nature or structure of business.[32]

Tax credit for small employers. Also effective immediately, certain small employers may qualify for tax credits for providing health insurance coverage to employees. The credits are available only to a company with 25 or fewer full-time equivalent employees earning an annual salary of $50,000 (indexed for inflation after 2013) or less. The company must pay at least half of its employees’ insurance premiums. From 2010 through 2013, the credits can be as high as 35% of the employer’s health care costs (25% for exempt organizations). In 2014 and beyond, credits are raised to as much as 50% of the employer’s health care costs (35% for exempt organizations). However, starting in 2014, employers must purchase coverage through a state health exchange to receive a credit, and the credits will be available for no more than two years. All tax credits are subject to phase-out if the number of employees exceeds 10 and/or the average wages exceed $25,000 (indexed for inflation after 2013). No credits are available for coverage provided to sole proprietors, partners, certain shareholders and owners, and their family members.[33]

Increased reporting requirements. A number of additional reporting requirements take effect between 2010 and 2014. For plan years beginning on or after September 23, 2010, a plan must provide participants with 60 days advance notice of any material modifications to the plan.[x34] Starting with the 2011 tax year, employers will be required to report on the Form W-2 the aggregate cost of applicable employer sponsored coverage.[35] By March 23, 2012, the Act requires employers to provide employees with a brief (no more than four page) explanation of benefits and coverage. HHS will develop a form that can be used for this purpose.[36] By March 1, 2013, employers must notify current employees and new hires of the existence of state health exchanges and the potential eligibility for tax credits.[37] Finally, beginning in 2014, employers will have additional reporting obligations to HHS and to individuals, including reporting whether the employer provides minimum essential coverage.[38]

Fee for covered lives. Health insurance issuers and plan administrators of self-insured plans will be required to pay a fee for each life covered under the plan or policy beginning for plan or policy years ending after September 30, 2012. The fee, which goes towards patient outcomes research, begins at $1 per covered life in the first year, rises to $2 per covered life in the second year, and will be adjusted for health care inflation beginning after September 30, 2014.[39]

Increased Medicare Hospital Insurance Tax for Certain Individuals. Employees currently pay a Medicare Hospital Insurance Tax of 1.45% of all wages and employers match the amount paid by employees. Effective January 1, 2013, the employee portion of the Medicare Hospital Tax will be increased by 0.9% on wages in excess of (i) $200,000 for individual taxpayers, (ii) $250,000 for married taxpayers filing jointly, and (iii) $125,000 for married taxpayers filing separately. The employer tax obligation will not increase—it remains at 1.45% of the employee’s wages. Employers will, however, be responsible for withholding an additional 0.9% on an employee’s wages over $200,000. (Any wages earned by the spouse are disregarded for purposes of determining the amount to be withheld.) An employer who fails to withhold the additional tax will be liable for the amount that should have been withheld if the employee fails to pay the additional tax later. Even if the employee does pay, the employer may still be subject to penalties for failure to withhold.[40]

Wellness program expansion. Employers without current wellness programs that have fewer than 100 employees working 25 or more hours per week may qualify to receive a grant under the $200 million workplace wellness program, which will be available beginning in 2011.[41] Employers will also have increased flexibility to increase wellness program rewards beginning on January 1, 2014.[42]

Cadillac plans taxed. Effective January 1, 2018, a new 40% excise tax on excess benefits under a “high-cost” or “Cadillac” health plans will take effect. The excess amount is generally equal to the cost of employer sponsored coverage less the applicable annual limitation. The limitation for 2018, which is subject to modification, will be $10,200 for individual coverage and $27,500 for other coverage. Costs for this purpose include employee contributions for coverage, as well as employer contributions to health FSAs and HSAs, but exclude costs related to stand-alone dental and vision plans. Employers will be responsible for identifying high-cost plans, making calculations of excise taxes, and notifying the Internal Revenue Service (“IRS”) and coverage providers.[43]

IV. Next Steps

Employers should immediately begin to review their health care plans to determine what changes will need to be made to comply with the Act.   The changes that are effective for plan years beginning on or after September 23, 2010 will likely increase the cost of benefits provided by the group health plan. Employers need to estimate these costs and determine how much of the additional costs will be borne by the employer and how much will be charged to the employees. With fall annual enrollment just a few months away, it is not too early to begin assessing what the Act means for an employer’s group health plan benefits.

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If you have any questions regarding this Alert, please contact Neal Gerber Eisenberg Employee Benefits and Executive Compensation Group members Patricia Cain (pcain@ngelaw.com, 312-269-8032), Jeffrey Bakker (jbakker@ngelaw.com, 312-269-8270) or Stephanie Vasconcellos (svasconcellos@ngelaw.com, 312-827-1042).