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June 9, 2011

Note to McKinsey: The Sky is NOT Falling, but it is Changing Colors!

The Sky is NOT Falling…but it is Changing Color: A thoughtful review of McKinsey’s report on employer health insurance benefits in light of Benfield’s new research regarding jumbo employer perspectives and strategies

Inboxes at The Benfield Group have seen a lot of traffic related to the recently released McKinsey Quarterly report, “How US health care reform will affect employee benefits.” The finding that is drawing a lot of attention is that “overall, 30 percent of employers will definitely or probably stop offering employer sponsored healthcare in the years after 2014.”

Or, as translated by the business press and popular media: “The sky is falling! The sky is falling!”

Benfield Research Report on Employer Market Health Care Reform is Now Available

This special report explores employers’ perspective on the impact and implications of healthcare reform. It reviews findings from our survey of 104 jumbo employers (5,000+ employees) and 20 supplemental interviews, highlighting current and future active and retiree health benefit considerations for 2011-2015 and beyond.
Click to Learn More

Having just completed in-depth interviews and a survey of over 100 jumbo, self-insured employers on the topic of health care reform (see sidebar), we can report that: “No, the sky is not falling…but it is changing color.”

Our intent here is not to call into question the research or findings being reported by McKinsey. Rather, we will explore areas of alignment and divergence in our evaluations of healthcare reform’s impact on employer sponsored healthcare. At the end of the day, there is no doubt (and should be no surprise to anyone) that healthcare reform is driving employers to examine a range of potential responses. However, our research indicates that—particularly for larger employers with higher-skilled and higher-wage workforces—economic and human capital management factors tip the scales in favor of continuing to provide healthcare benefits to employees and their dependents.

What You Hear Depends on Who You Talk To

We agree with an overarching conclusion made by our colleagues at McKinsey who state: “The discussion to date has largely focused on dropping vs. keeping coverage, but for most employers the value-creating options lie in-between.” What the “value-creating options” look like, however, vary dramatically for employers of different sizes and different mindsets about their human capital.

When The Benfield Group does employer research, we listen to employers with 5,000 or more employees (a.k.a. “jumbo” employers) who are almost always self-insured and who—by their actions—drive much of the innovation in health care benefits, policies and programs among health insurers, providers and other vendors along the health care supply chain.

In their research, McKinsey listened to the entire employer market spectrum; from small employers who simply go along with their brokers’ annual recommendations of a lowest-price health plan, to mid-size employers who are more thoughtful but wield little market influence, to jumbo employers who are more strategic in their approach and more influential in their decisions about managing the health and health benefits of their human capital.

Assessing Alignment

McKinsey’s finding that 30-50% of employers could drop employer sponsored insurance (ESI) after 2014 is clearly provocative enough to generate fantastic headlines. The numbers, at face-value, are staggering: approximately 1.8 to 3.0 million employers in the US could drop healthcare coverage entirely, pay required penalties and shift their populations into the health exchanges. However, it is notable that this will not happen immediately in 2014, as only employers with fewer than 100 employees will have access to the health exchanges, while larger employers won’t have access to exchanges until 2017. Of course, many things could change in healthcare reform by then, and further, Benfield’s panel of jumbo employers want to ensure that exchanges provide cost-effective, quality healthcare before they would consider shifting even their retirees into these plans.

Under the right circumstances—and some might say extreme circumstances—Benfield’s research suggests that some jumbo employers could drop ESI. However, when we asked about what would cause employers to exit employer sponsored healthcare, the responses we received focused more on the need to compete for talent than to manage costs. In fact, nearly three-quarters of employers we surveyed indicated that “competing for talent” was the main factor they would consider in a decision to continue providing health and pharmacy benefits to employees. Conversely, when asked the likelihood of discontinuing benefits to their employees, 21% said they were highly likely and 49% somewhat likely to drop coverage if their industry competitors stopped offering health benefits. Think “arms race,” with health care benefits as weaponry. Economics of the decision came in second to talent retention concerns.

Looking at the strategic options that employers are considering in response to healthcare reform, Benfield and McKinsey are in agreement that a significant portion of employers are considering alternatives to the traditional employer sponsored coverage. McKinsey’s report states: “45 to 50 percent of employers say they will definitely or probably pursue alternatives to ESI in the years after 2014. These alternatives include dropping coverage, offering it through a defined-contribution model, or in effect offering it only to certain employees.” Benfield’s panel of jumbo employers see a significant shift to CDHP plans between now and 2014, in what appears to be a transition strategy. From 2015 and beyond, jumbo employers begin to pursue these alternatives: maintain coverage and participate to some degree in private or public exchanges, or offer the equivalent of the government “Bronze Plan” as a base plan with an employee option to buy up for additional coverage, or reduce benefit offerings to avoid the Cadillac tax.

Findings for Benfield and McKinsey also agree in that, regardless of health insurance coverage, employers will continue to offer population health programs because—as McKinsey report states—“ …(employee) health, productivity and satisfaction will continue to be important.”

Points of Divergence

The main point of divergence between the two research reports revolves around the question: Will employers benefit economically if they drop healthcare coverage? Here, we think our focus on jumbo employers leads us to a different conclusion. McKinsey reports it is advantageous for employers to drop healthcare coverage and pay the penalty vs. bear cost of continuing to provide coverage. Meanwhile, Benfield’s jumbo employer panel indicated that the math behind dropping ESI doesn’t work out to an economic benefit. Consider this employer perspective:

“When we study the economics, we just don’t see it making good long term sense, because benefits are on a pre-tax basis. If you take whatever you’re spending today on behalf of your employees and give that to them saying “go out and buy what you can with that,” then you have to do a couple things (to keep employees whole). One, you’ve got to make up to them the tax basis that they’re now going to have to account for as income. And two, in doing so, you’re going to have to replace the lost income to them in their overall remunerations. When we study the numbers in our work force, we just don’t see it in our economic interest to (drop coverage) for our entire population.”

No doubt, McKinsey’s findings reflect the fact that dropping ESI makes a great deal of sense for certain employers. For instance, small employers (less than 50 employees) that are exempt from PPACA “play or pay” penalties, or employers that have a large percentage of low-wage workers that will qualify for Medicaid or premium subsidies are likely to benefit economically by shifting workers to the exchanges. For employers with higher-wage employees, it is in their best interests to maintain employer-sponsored coverage.

To make the numbers more tangible, consider the following example from Milliman1:

“Let’s say you’re currently paying 80% of employee premiums and decided to terminate your plan. If you wanted to increase cash compensation to allow purchasing the same policy on the exchange, it would cost the following for an employee (family coverage) at a 35% marginal tax rate:

  • $15,600 more in salary to pay for exchange coverage ($19,500 estimated 2014 total premium equivalent to the Silver Plan)
  • $10,500 more in salary to pay the additional taxes necessary to increase net pay by $19,500 (additional taxes on $15,600 salary increase and former $3,900 employee premium contribution)
  • $2,300 in additional employer payroll taxes (7.65% of $30,000 – taxable salary increase)
  • $2,000 PPACA penalty for not offering a qualified health plan (with additional taxes for non-tax-exempt employers).

You would spend $15,600 on the employee’s health insurance if the plan continues. However, the cost of providing equivalent cash compensation balloons to $30,400 – an increase of nearly 95% in your cost.”

In addition to concerns over competing for valuable (and increasingly scarce) human capital talent, the math behind the decision is likely behind our finding that only 7% of jumbo employers are considering dropping active employee healthcare coverage in 2015 and beyond. An additional 7% of jumbo employers are considering dropping healthcare coverage, but will provide employee vouchers or supplemental compensation.

Summary

The perspectives, motives and strategies of jumbo employers are different than all employers, regardless of size. Benfield’s research indicates that jumbo employers will remain active and involved in healthcare decisions and benefits offerings for their employees and dependents for the foreseeable future. However, as we’re seeing play out, many specifics of PPACA are still being determined, and with another election cycle standing between now and full implementation, much can change. As such, employers will continue to strategically evaluate their options in light of both financial and human capital consequences as they seek to grow and profit in a globally competitive marketplace.

If you are interested in learning more about how to purchase the Benfield Research Healthcare Reform Special Report, please click the following link: Benfield Research Special Report: Employer Market Healthcare Reform

1Benefits Perspective, Milliman, Winter 2010/2011