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Health Care Reform and Employer Health Benefits for

Non-Medicare Retirees

Mark Merlis Independent Consultant

Health Care Reform and Employer Health Benefits for

Non-Medicare Retirees

Mark Merlis Independent Consultant

AARP’s Public Policy Institute informs and stimulates public debate on the issues we face as we age. Through research, analysis and dialogue with the nation’s leading experts, PPI promotes development of sound, creative policies to address our common need for economic security, health care, and quality of life.

The views expressed herein are for information, debate, and discussion, and do not necessarily represent official policies of AARP.

# 2010-02 January 2010 © 2010, AARP Reprinting with permission only

AARP Public Policy Institute 601 E Street, NW, Washington, DC 20049 http://www.aarp.org/ppi

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TABLE OF CONTENTS EXECUTIVE SUMMARY .................................................................................................. v

INTRODUCTION............................................................................................................... 1

NON-MEDICARE RETIREES AND THEIR HEALTH BENEFITS TODAY ...................... 1

CHANGES IN INCENTIVES UNDER HEALTH REFORM AND THE POTENTIAL FOR CROWD-OUT OF RETIREE BENEFITS .......................................................................... 4

Market Rules................................................................................................................. 5 Insurance Mechanisms.................................................................................................. 7 Premium Subsidies...................................................................................................... 10

OPTIONS FOR REDUCING CROWD-OUT OF RETIREE COVERAGE ....................... 11

OTHER POTENTIAL ISSUES FOR NON-MEDICARE RETIREES ............................... 13

Tax Exclusion for Employer-Provided Benefits......................................................... 13 Medicare and Medicaid Changes................................................................................ 14

CONCLUSION................................................................................................................ 15

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Tables Table 1. Non-Medicare Retirees and Dependents of Non-Medicare Retirees with

Employer Health Coverage, 1991–2007 (millions) .......................................... 2

Table 2. Non-Medicare Holders of Retiree Coverage by Family Income, 2007 ............ 2

Table 3. Percent of Private Establishments Offering Health Benefits to Retirees under Age 65................................................................................................... 3

Table 4. Retirees with Employer Coverage by Employer Contribution Policy ............... 4

Table 5. Last Reported Premium Contribution, Non-Medicare Retirees with Employer Coverage in December 2006 .......................................................... 4

Table 6. Average Annual Per Capita Private Insurance Spending for Active Workers and Retirees with Employer Coverage, by Age, 2006 ..................... 6

Table 7. Estimated Effects of Restriction on Use of Age in Rating, 2006...................... 7

Table 8. Non-Medicare Retirees, by Employer Contribution Policy and Subsidy Eligibility, 2006 .............................................................................................. 10

Health Care Reform and Employer Health Benefits for Non-Medicare Retirees

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EXECUTIVE SUMMARY

Comprehensive health reform measures could help early retirees who do not receive coverage through their former employers and who may not be able to find affordable insurance in the private nongroup market. However, measures that would make individual coverage more accessible or less costly might at the same time reduce the incentives for employers to continue to offer or employees to accept retiree health benefits.

This research was undertaken over the course of the reform debate this past year. It explores what key reforms, proposed as of September 2009, could mean for several million early retirees, not yet eligible for Medicare. At this writing, Congress has yet to reach a consensus on details of a health reform plan. However, many of the proposals under consideration share some common concepts or design features. This report examines the potential effects of some of these policy options on non-Medicare retirees, with a focus on those currently covered through former employers.

CURRENT STATUS OF RETIREE BENEFITS The number of non-Medicare retirees receiving employer health benefits has remained roughly stable, around 3 million, since the early 1990s. As the total retired population has grown, however, the percentage with coverage has steadily dropped. Offers of coverage by large employers have continued the declines that began in the 1980s; coverage by smaller firms is rare, and almost no businesses started in the last 20 years offer retiree benefits. This means that, regardless of the future policies of employers still offering coverage, retiree coverage will decline as the workforce moves into new firms or industries. Benefits may also be threatened in the state and local governments that have been the most reliable source of retiree coverage, because of changes in accounting rules that require them to list unfunded future retiree health benefits as a liability. Many firms that continue to cover nonelderly retirees will not be offering this coverage to some of their currently active workers when they are ready for retirement. Finally, many employers have been reducing their percentage contributions to retirees’ premiums or have imposed a cap, a fixed maximum dollar amount the employer will pay, regardless of how much premiums rise in the future.

CHANGES IN INCENTIVES AND THE POTENTIAL FOR CROWD-OUT The effects of a health reform plan are likely to be different for people who are already retired (or very near retirement) and for people who are still some years away from retirement. For current retirees, employers might be expected to curtail coverage only if the retirees would be about as well off in the new insurance/subsidy arrangements as they are today. The trade-offs are different for future retirees, who are—at least in theory—accepting a promise of future benefits in lieu of other forms of compensation, such as higher wages or more comprehensive health coverage today. If health reform provides alternative routes to coverage for these workers in retirement, they might prefer other benefits, accelerating the existing trend away from retiree coverage. The likelihood that health reform will lead to crowding out of retiree health benefits depends on three key issues:


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• How would retirees, especially those with health problems, fare under the rating and other market rules established for nongroup coverage?

While a consensus has emerged that insurers will need to guarantee issue in the nongroup market, there is still a debate on the extent to which they could vary premium rates by age or other factors. Full community rating would mean nongroup premium rates well below what employers are paying for non-Medicare retirees, and could lead to rapid drops in coverage. Even if age rating were permitted, there could be some incentive for shifting, because early retirees tend to have higher costs than active workers in the same age class. The incentive would be larger if, as in some proposals, there were a highly restrictive limit on age variation.

• Would new insurance mechanisms, such as an insurance exchange or a public plan, be able to match the lower administrative costs or other price advantages of group plans?

The reform plans include two mechanisms that some people think might reduce the price advantages enjoyed by large groups: a health insurance exchange and a public insurance plan. While plans in an exchange might have lower marketing and other costs than current nongroup carriers, it is unlikely that they can bring administrative costs to the level of large employers, because of added expenses associated with individual enrollment and premium collection. For the same reason, a public plan might have limited administrative savings; whether it would have lower costs overall would depend on whether it would be given some advantage in price negotiations with providers or would instead operate on a level playing field. Finally, some plans include federal reinsurance for catastrophic cases in employer retiree plans. Depending on the coverage threshold, this could provide considerable savings for employers and perhaps encourage some to continue retiree coverage.

• How would tax credits or other subsidies available to retirees compare to the subsidies (if any) currently provided by their employers?

A majority of non-Medicare retirees would potentially qualify for nongroup premium subsidies under current proposals. Those receiving large, tax-favored premium contributions from their employers might still be better off remaining in their group plans. However, because of the contribution freezes imposed under many employer plans, the number of retirees finding subsidized nongroup coverage more advantageous would be likely to grow steadily over time. The incentive for shifting would be reduced if, as in some proposals, a subsidy would be available for the employer plan if required premiums exceeded some percentage of the retiree’s income. However, this could simply lead employers to reduce their own contributions.

OPTIONS FOR REDUCING CROWD-OUT There might be ways of reducing the incentives for coverage-shifting. Employers could receive direct subsidies for continuing retiree coverage, much as they do under the Medicare prescription drug program. However, this would be costly and cumbersome. People with access to retiree coverage could be required to accept it, but this would penalize those with little or no employer premium contribution. Finally, a universal risk adjustment scheme, covering both nongroup and employer plans, could make it less likely that employers with high-cost retirees would drop coverage.


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TAX ISSUES Some proposals would limit the exclusion of employer premium contributions from workers’ income and, presumably, from retirees’ income as well. A fixed ceiling on employer contributions, perhaps based on some national average, would raise serious problems for retirees. If employers pooled active workers and retirees together, the higher costs of retirees could cause the whole pool to exceed a cap. If retirees were grouped separately, their costs would certainly exceed an average-based limit, unless a separate ceiling was set for retiree benefits.

MEDICARE AND MEDICAID CHANGES Some possible changes in public program eligibility could affect some number of current retiree health plan enrollees. Proposals to eliminate the Medicare waiting period for the disabled could extend Medicare benefits to about 8% of current non-Medicare retirees with employer benefits. Extending Medicaid to everyone below poverty, without categorical restrictions, would also affect about 8% of retirees (mostly a different group from those affected by the Medicare option).

Employer contributions to health costs for non-Medicare retirees and their dependents may be in the range of $15 billion a year. If crowd-out under health reform led to the replacement of these contributions with federal subsidy dollars, the budgetary effects would not be negligible. But measures to prevent crowd-out would be complicated and have a limited chance of success. On balance, it seems sensible to conclude that comprehensive health reform would speed the erosion of retiree benefits. Crowd-out of existing benefits for some retirees may be the price that must be paid to assist the many other retirees who are currently uninsured or faced with extremely high costs in the nongroup market.


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INTRODUCTION

In 2007, 4.3 million non-Medicare retirees and dependents received health insurance coverage from their former employers. While employers often require retirees to pay a larger share of their premiums than active workers, continued access to group coverage has provided vital protection for people who, because of age and health status, might have difficulty finding coverage in the nongroup market at a price they could afford—or, in many states, any coverage at all.

Congress is considering a variety of health reform proposals intended to make affordable coverage available to every American, by changing the organization and regulation of the health insurance marketplace and providing some form of federal premium subsidy to lower-income people. While there is considerable variation among the plans that emerged from congressional committees as of September 2009, all of them would help non-Medicare retirees who do not currently have access to employer benefits. However, measures that could help uninsured retirees might at the same time reduce the incentives for employers to continue to offer or employees to accept retiree health benefits. If retirees could find affordable coverage outside their group plans, and if tax credits or other subsidy arrangements could substitute for the premium contributions now made by employers, there might be some immediate “crowd-out.” Current retirees might be forced out of their group plan or choose to leave it. Perhaps more likely would be an acceleration of the existing trend toward gradual erosion of employer offers of future coverage for workers who are still some years away from retirement.

This report examines the potential effects of reform plans on non-Medicare retirees, with a focus on those currently covered through former employers. It begins with a review of recent trends in retiree coverage and data on characteristics of the population with this coverage. This is followed by a discussion of how some of the basic concepts or design features that are included in one or more proposals might affect retirees.

NON-MEDICARE RETIREES AND THEIR HEALTH BENEFITS TODAY

The number of non-Medicare retirees receiving employer health benefits has remained roughly stable, around 3 million, since the early 1990s. As the total retired population has grown, however, the percentage with coverage has steadily dropped. There also appears to have been a drop in the absolute number of people who had employer coverage as dependents of a non-Medicare retiree.

Many retirees without coverage through their former employer are covered through a spouse or other family member who is still employed, purchase private coverage in the nongroup market, or are covered by Medicaid or other public programs.1 However, 20% of non-Medicare retirees—1.4 million retirees—reported that they were without health insurance in 2007.

1 One of these is Tricare, which provides benefits to many military retirees. Because Tricare would presumably not be affected by

health reform, it is not treated as retiree coverage in this report.


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Just over half of non-Medicare retirees with employer coverage have incomes below 400% of the federal poverty level, the cut-off for publicly subsidized coverage under a number of the proposals. The implications will be discussed in the section on premium subsidies, below.

The relative stability of the population with retiree benefits is partly attributable to the fact that these benefits continue to be available to federal annuitants and to employees of nearly all state and large local governments. The number of private employers offering retiree health coverage dropped precipitously between the mid-1980s and the early 1990s, partly in response to changes in accounting rules that required firms to include future liability for retiree health benefits on their balance sheets. As table 3 shows, there has been continued erosion over the last decade.

Coverage by smaller firms was never common, and almost no businesses started in the last 20 years offer retiree benefits. This means that, regardless of the future policies of employers still offering coverage, retiree coverage will decline as the workforce moves into new firms or industries. Benefits may also be threatened in the state and local governments that have been the most reliable source of retiree coverage, because of changes in accounting rules that

Table 1 Non-Medicare Retirees and Dependents of Non-Medicare Retirees with Employer Health

Coverage, 1991–2007 (millions) 1991 1998 2004 2007

Retirees 2.8 3.1 3.4 3.2 Dependents NA 2.1 1.5 1.5 Total NA 5.2 4.9 4.8 Retirees with coverage as % of all non-Medicare retirees

58.4% 49.9% 47.1% 44.5%

Author’s analysis of March supplement to Current Population Survey (CPS) 1992, 1999, 2005, and 2008 (renamed Annual Social and Economic Supplement, ASEC, beginning in 2003); data in the CPS reflect coverage during the preceding calendar year. Numbers for 2004 and 2007 are not precisely comparable to those for earlier years because of changes in the survey. Figures exclude active workers who may be receiving retiree benefits from a former employer.

Table 2 Non-Medicare Holders of Retiree Coverage by

Family Income, 2007 Family Income Percent of Holders

Under 200% of poverty 20% 200%–399% of poverty 31% 400% of poverty and over 49% Total 100%

Author’s analysis of 2008 Annual Social and Economic Supplement (ASEC).

Health Coverage, Non-Medicare Retirees, 2007

Author’s analysis of 2008 Annual Social and Economic Supplement (ASEC). Public insurance includes Medicaid and other state programs, Tricare, and VA benefits.


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require them to list unfunded future retiree health benefits as a liability. One recent survey found that, among public employers familiar with the new rules, 80% were “very” or “somewhat concerned” about the future financial impact.2

Many firms that continue to cover nonelderly retirees will not be offering this coverage to some of their currently active workers when they are ready for retirement. In 2008, firms offering coverage to retirees under age 65 reported that 72% of active employees would be eligible if they remained with the firm until retirement. Of these firms, 71% reported that “at least some” new hires would be eligible for early retiree benefits.3 The flip side of these figures is that over one-fourth of the firms are now operating legacy programs available only to people who joined the firm at some time in the past.

Finally, many employers have been reducing their percentage contributions to retirees’ premiums or have imposed a cap, a fixed maximum dollar amount the employer will pay, regardless of how much premiums rise in the future. Among firms with 1,000 or more employees, 46% had imposed a cap on their largest plan for nonelderly retirees as of 2006. Of these, 60% had already hit the cap, while another 23% expected to hit the cap within the next 1 to 3 years.4 Unless the cap is waived, workers in these firms will be covering all premium increases on their own, making their employer plan steadily less valuable.

Table 4 gives three estimates of the distribution of employer contribution policies. The data from the March 2008 ASEC, reflecting contribution levels in 2007, are based on counts of retirees; the same is true for the 2006 MEPS data. The data from the 2006 Kaiser/Hewitt survey are based on counts of firms. Note that the share of retirees reporting in ASEC and MEPS that their former employer paid the full premium is much larger than the share of firms reporting that they paid the full premium. This might be because firms with the

2 Jon Gabel, Heidi Whitmore, and Jeremy Pickreign, Retiree Health Benefits After Medicare Part D: A Snapshot of Prescription

Drug Coverage, New York, Commonwealth Fund, Sept. 2008. 3 Henry J. Kaiser Family Foundation and Hewitt Associates (Kaiser/Hewitt). Retiree Health Benefits Examined: Findings from the

Kaiser/Hewitt 2006 Survey on Retiree Health Benefits, Menlo Park, CA, and Lincolnshire, IL, Dec. 2006. Note that this survey classes retirees by age rather than by Medicare status.

4 Kaiser/Hewitt.

Table 3 Percent of Private Establishments Offering Health Benefits to Retirees under Age 65

1997 2003 2008 All Private Establishments

11% 7% 6%

Establishment Size Less than 10 employees 3% 0% 0% 10–24 employees 7% 2% 1% 25–99 employees 12% 2% 2% 100–999 employees (1997 and 2003)

24% 10% 8%

1,000+ employees (1997 and 203)

52% 42% 36%

Age of Establishment Less than 5 years 2% 0% 0% 5–9 years 3% 1% 0% 10–19 years 5% 1% 1% 20 or more years 23% 10% 9%

Union Presence No union employees 9% 4% 4% Has union employees 39% 37% 32%

Author’s calculation from Medical Expenditure Panel Survey, Insurance Component data available at http://www.meps.ahrq.gov/mepsweb/data_stats/ quick_tables_search.jsp?component=2&subcomponent=1.


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largest numbers of retirees were more likely to have this policy. Another factor might be that the Kaiser data reflect employers’ contribution policies for employees newly retiring in 2006, while the ASEC and MEPS data include people who retired in some earlier year and were not affected by more recent changes in employer policies. The Kaiser/Hewitt data do not precisely indicate what share of the premium is being contributed by the employers making partial contributions, but calculations from the published data suggest that the average is in the range of 56%.

As is true of active employees, retirees with family coverage pay a larger share of the premium than those with self-only coverage. Table 5 shows the distribution for non-Medicare retirees reporting coverage in December 2006. (Note that, while MEPS participants are interviewed six times over a two-year period, the premium for any particular health plan is ascertained only in the first interview during which the plan is mentioned. This means that, for someone reporting coverage in December 2006, the latest premium data could be from early 2005. Thus the figures in table 5 likely understate actual contribution levels.)

CHANGES IN INCENTIVES UNDER HEALTH REFORM AND THE POTENTIAL FOR CROWD-OUT OF RETIREE BENEFITS

The effects of health reform are likely to be different for people who are already retired (or very near retirement) and for people who are still some years away from retirement. For current retirees, employers might be expected to curtail coverage only if the retirees would be about as well off in the new insurance/subsidy arrangements as they are today. The trade-offs are different for future retirees, who are—at least in theory—accepting a promise of future benefits in lieu of other forms of compensation, such as higher wages

Table 4 Retirees with Employer Coverage by Employer Contribution Policy

ASEC Non-Medicare

(2007): Percent of All Retirees

with Coverage

MEPS Non-Medicare (2006):

Percent of All Retirees with Coverage

Kaiser-Hewitt Nonelderly (2006): Percent of Firms Offering Retiree

Coverage Employer Contributes

Full premium 23% 31% 8% Part of premium 66% 55% 75% Nothing 11% 13% 17%

Total 100.0% 100% 100% ASEC 2008, MEPS 2006, and Kaiser/Hewitt 2006.

Table 5 Last Reported Premium Contribution,

Non-Medicare Retirees with Employer Coverage in December 2006 Retiree’s Monthly

Premium Contribution Single Family Zero* 30% 24% Under $100 21% 6% $100–$199 30% 25% $200–$349 11% 21% $350–$499 4% 9% $500–$999 5% 8% $1,000 or more 0% 6%

100% 100% * The numbers for this row are inconsistent with those in table 4, because a handful of respondents reported that their employer paid the full premium and also reported that they made some premium contribution. Source: MEPS 2006.


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or more comprehensive health coverage today. Outside the abstract world of economists, workers seldom directly negotiate the terms of their compensation (although the exchange between retiree health and other benefits has been explicit in some union/employer bargaining). Still, employers are offering retiree coverage because they believe their employees find it valuable.

At least implicitly, the employers and their workers are calculating that the net present value of retiree coverage is greater than that of other possible forms of compensation. This implicit calculation already includes some discount for uncertainty—about whether the worker will remain with the same firm until retirement or the employer will maintain the current plan in the years ahead. Given this discount, the coverage available to retirees under a health reform proposal might not have to be equal to the coverage under an employer plan to lead to crowd-out. If it were simply perceived as adequate, workers might begin to prefer other forms of compensation, and employers would gradually accommodate these preferences. (Of course, the decline in offers of retiree coverage to newer workers suggests that this is already not a highly valued benefit, while some employers are cutting coverage regardless of their employees’ preferences. Easier availability of alternative coverage would simply accelerate these existing trends.)

For both current and future retirees, any comparison of the value of their employer plan and the plans available under health reform would be a function of at least three factors:

• How would retirees, especially those with health problems, fare under the rating and other market rules established for nongroup coverage?

• Would new insurance mechanisms, such as an insurance exchange or a public plan, be able to match the lower administrative costs or other price advantages of group plans?

• How would tax credits or other subsidies available to retirees compare to the subsidies (if any) currently provided by their employers?

One additional factor will not be considered here: how the benefit packages available under any new arrangements might compare to those of current retiree plans. Benefit specifications in current proposals are too vague to allow any detailed comparisons, although most retiree plans are probably at least as generous as the minimum coverage likely to be available in the nongroup market. Plan variation and individual preferences could mean that there would be some amount of shuffling of enrollees from more/less comprehensive retiree group plans to more/less comprehensive nongroup or exchange plans, with indeterminate selection effects. And erosion of retiree benefit packages over time could change the balance. At least initially, however, benefit differences are unlikely to be an important factor in the viability of retiree coverage.

MARKET RULES A consensus has emerged that nongroup insurers would be required to guarantee issue and renewal and that the use of pre-existing condition exclusions would be restricted or eliminated. This means that retirees could shift (or be shifted) into the nongroup market without fear that they would be denied coverage. Whether they could find a more favorable premium rate for comparable coverage is less clear. Some early proposals would have required something close to pure community rating, with insurers permitted to vary


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premiums only by family size, geography, and tobacco use or participation in wellness programs. But proposals now under consideration, while prohibiting the use of health risk factors, would allow premiums to vary by age. The degree of variation might be restricted; for example, the ratio of the highest to the lowest age-based rate might be 5 to 1 or even 2 to 1. The precise ratio chosen might have an important effect on retiree coverage.

Table 6, using MEPS data, compares 2006 private health insurance spending for active workers and retirees with employer coverage. (The figures exclude spending for dependents, amounts paid out of pocket, and private insurance administrative costs.) The average non-Medicare retiree is much more costly than the average active worker—$4,707 versus $2,315 per year. This is partly because retirees are older than the average worker. However, even within a given age group, retirees are more costly than those who are continuing to work. (This might be because at least some retirees have left work early for health reasons.) Because this comparison is limited to people with employer coverage, it may not reflect the exact difference between retirees and the broader population, but should be sufficient for the purposes of illustration.5

Retirees would see dramatically lower premiums if they shifted into a nongroup market (or exchange or public plan) that used full community rating. Allowing age rating would reduce the likelihood of retirees moving out of their group plans and into the nongroup market. Still, if retirees are higher-cost than their contemporaries—as the estimates in table 6 suggest—it appears that they might see savings if they shifted to the community pool. For the 60–64 age group, which represents 70% of early retirees, per capita benefit costs could drop from $5,310 to $4,425, a 17% reduction.

However, the numbers in table 6 represent health spending only, and not the additional costs of administration and (for insured plans) surplus or profit. Administrative costs and insurer profits for large groups may be in the range of 8%-10% of premiums, versus 20%-30% or more for small groups and nongroup purchasers. Suppose that benefit costs for non-Medicare retirees aged 60 and older were, as shown, $5,310 compared to $4,425 for all non-Medicare people in this age group. If administrative costs made up 8% of the premium for a large group and 30% for a nongroup plan, the retiree plan would have a premium of $5,735 and the

5 Presumably, if people with nongroup coverage or the uninsured received coverage as comprehensive as that provided to employer

groups, their utilization would rise to the levels of comparable group enrollees.

Table 6 Average Annual Per Capita Private Insurance

Spending for Active Workers and Retirees with Employer Coverage, by Age, 2006

Age Active

Workers Non-Medicare

Retirees Total Under 25 $ 819 * $ 821 25–34 $ 1,632 * $ 1,657 35–44 $ 1,802 * $ 1,885 45–54 $ 2,589 * $ 2,655 55–59 $ 3,689 $ 3,957 $ 3,797 60–64 $ 4,145 $ 5,310 $ 4,425 All ages $ 2,315 $ 4,707 $ 2,451

*Sample too small for meaningful estimate. Author’s analysis of the 2006 Medical Expenditure Panel Survey (MEPS). Estimates are limited to people with full-year employer coverage in their own name and no Medicare coverage. Total includes nonworkers giving a reason other than retirement; worker figure may include active workers with retiree benefits from a previous job. Estimates are of total private insurance spending; some people with both group and nongroup coverage might have had spending under both plans.


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nongroup plan a premium of $5,753. The potential cost saving for a retiree shifting coverage would disappear. Of course, a key feature of all current reform plans is a set of new insurance mechanisms that, it is hoped, would reduce the difference in costs for group and nongroup coverage. The effectiveness of these mechanisms might be an important determinant of the long-range survival of retiree group coverage.

The picture is somewhat different if market rules include some restriction on the extent to which premiums can vary by age. Table 7 compares age-adjusted community benefit costs with no restriction and with a 2:1 limit on the ratio of the highest to the lowest rate. (The unrestricted ratio is about 5.4:1, just above the 5:1 ratio allowed in some less restrictive reform plans.) Again, both columns omit administration and profit. But the savings of almost $2,000 in benefit costs from shifting older retirees to nongroup coverage with tight rating bands would far outweigh any administrative cost advantage of a large group plan.

The incentives for shifting could be reduced through a risk adjustment system that included both insurance plans sold to individuals and group health plans maintained by employers. Under such a system, if a group plan restricted to retirees had a higher risk profile than non-employer plans, revenues would be transferred from those plans to the retiree plan, allowing it to reduce its premium. However, while some current proposals include risk adjustment, most provide for transfers only among different insurance companies serving the same broad target population—such as the participants in a health insurance exchange. (The same is true of most existing risk adjustment systems, such as those used in Medicare Advantage or in the Dutch health care system.) In these arrangements, insurers are competing for enrollees within a common pool, and the system compensates for random (or deliberate) selection bias. To help stabilize retiree plans, a risk adjustment system would have to move funds from nongroup insurance plans serving one population to employer plans (often self-insured) serving another. This would represent a visible tax on the lower-risk population and could face political barriers.6

INSURANCE MECHANISMS Current reform plans include mechanisms that some people think might reduce the price of coverage for nongroup and small group purchasers, such as a health insurance exchange and a public insurance plan competing with private insurers. The following discussion will

6 On the other hand, if there were no risk adjustment and retirees shifted into the nongroup community plans, younger and lower-

risk people would pay the same aggregate amount (hidden in the adjusted community rate) to cross-subsidize the sicker members of the pool.

Table 7 Estimated Effects of Restriction on Use of Age in

Rating, 2006

Age Retiree Costs

Unrestricted Age Rating in

Nongroup Market

With 2:1 Restriction

Under 25 $ 821 $ 1,688 25–34 $ 1,657 $ 2,079 35–44 $ 1,885 $ 2,186 45–54 $ 2,655 $ 2,546 55–59 $ 3,957 $ 3,797 $ 3,081 60–64 $ 5,310 $ 4,425 $ 3,375

Author’s analysis of the 2006 Medical Expenditure Panel Survey (MEPS). Estimates are limited to people with full-year employer coverage in their own name and no Medicare coverage. Total includes nonworkers giving a reason other than retirement; worker figure may include active workers with retiree benefits from a previous job. Estimates are of total private insurance spending; some people with both group and nongroup coverage might have had spending under both plans.


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assume that these options are closed to employers offering retiree health benefits. (The option of allowing employers to purchase retiree coverage through these arrangements is considered at the end of this paper.) If either mechanism could reduce the current price advantages of large group coverage, this might speed erosion of retiree plans. On the other hand, another proposed insurance mechanism, reinsurance for high-cost retirees, could reduce employer spending and help stabilize coverage over the short term.

Insurance Exchange Some people believe that an insurance exchange would reduce administrative costs. The Lewin Group’s cost estimates for the Wyden proposal assume that the exchange itself would have costs of 3.2% of premiums to perform its enrollment, risk adjustment, and other functions, and that participating insurers would have administrative costs equal to those of the largest employer groups.7 These they peg at 3.4% of claims, using a 1988 estimate that is certainly too low; the largest of all employer groups, the FEHBP Blue Cross standard plan, had costs equal to 7% of premiums in 2003.8 Whatever the correct figure, it seems improbable that exchange plans offered to individuals could bring their administrative costs down to the large group level. Some costs, such as those associated with underwriting, would be eliminated. (This would also be true for non-exchange plans if they were subject to the same market rules as exchange plans.) However, there would still be marketing costs, as well as new costs—for example, to comply with the exchange’s data needs for risk adjustment. (There may also be premium taxes, which are not paid by self-insured employer plans but which states will certainly wish to collect from exchange plans.) And even if plans in the exchange could meet the costs of large groups, the additional exchange costs associated with individual enrollment, premium billing, and so on could bring the total to a figure well above the large group level.

Administrative costs aside, proponents of managed competition theorize that an organized market with standardized benefits would promote price competition and hence greater efficiency and/or reduced profit-taking among participating carriers. The Congressional Budget Office (CBO) appears to concur in this view, projecting savings of up to 5% relative to current premium levels if premium subsidies are set at or below the cost of the lowest-priced available plan, so that enrollees pay all the excess cost of higher-priced plans.9 Savings are likely to be smaller if subsidies are instead pegged to the price of the average plan in an area. This is the rule under the Massachusetts system, and it may be that this comparatively loose competitive model represents the limit of what is politically possible.

Public Plan The idea of a public plan has already emerged as one of the most controversial issues in health reform. This report will not rehearse the entire debate, but will merely point out that potential savings depend on the precise model that might be adopted.

7 John Sheils, Randall Haught, and Evelyn Murphy, Cost and Coverage Estimates for the “Healthy Americans Act,” Falls Church,

VA, The Lewin Group, Dec. 2006. 8 Abby Block, Senior Advisor for Employee and Family Policy, OPM, testimony before the Senate Finance Committee, Apr. 3,

2003. 9 U.S. Congressional Budget Office (CBO), Key Issues in Analyzing Major Health Insurance Proposals, Washington, Dec. 2008.


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A public plan would have some administrative cost advantages in comparison to private plans competing with it in the nongroup or small employer markets. It would not have to return a profit to shareholders and it might not have to retain any risk reserves (assuming the government would guarantee its losses). It might have lower marketing costs than its competitors. But large, self-insured employer plans have no marketing costs, establish no reserves, and provide no profit to insurers. It is not clear how a public plan would achieve significantly lower administrative costs than typical retiree group plans.

The major potential price advantage of a public plan would be its possible ability to command discounts from providers. Some proposals call for what has been characterized as a “strong” public plan, which would set fixed rates for services. This could give the public plan a direct price advantage over employer plans; the gap might be widened if providers responded by cost-shifting to employers and private insurers. Other proposals would provide for a level playing field, with the public plan negotiating prices on the same basis as other payers. It might still have some competitive advantage if it had a large market share, but providers might have little incentive to help it in its competition with private plans by granting discounts.

An alternative that has received some discussion, health care cooperatives, has not at this point been described in sufficient detail to permit analysis. It is not clear what price advantage such organizations might enjoy, other than the fact that they would not need to produce returns for shareholders. But there have always been nonprofit insurers, such as Kaiser Permanente and some of the Blues; it is not clear that their status has given them any competitive edge.

Reinsurance Several proposals would provide reinsurance for high-cost individuals in employer-based retiree health plans. Once an enrollee’s expenses exceeded a given threshold, a federal program would assume responsibility for much of the cost. Proposals to date have included fixed limits on federal spending for this purpose, meaning that reinsurance would end once funds were exhausted. They would also require that employers use savings resulting from the program to reduce the premiums or cost-sharing paid by retirees. This provision means that the reinsurance could make it more attractive for individual retirees to retain their current coverage. However, as employers would see no net savings, they might still have an incentive to drop the plan and shift all retirees into nongroup coverage.

The potential effects of reinsurance depend very much on where the coverage threshold is set. Senator Kerry’s proposal earlier this year (S. 79), which applied to active workers, would have paid any employer 75% of costs for an individual worker in excess of $50,000 in a year. If a similar rule had applied to retirees in 2006, total benefit costs would have been reduced by about 16%.10 The more recent proposals for retirees use a $15,000 threshold and cover 80% of costs above this level, up to a limit of $90,000. A plan of this kind would have reduced benefit costs by 25%. It should be emphasized that these estimates are based on a single year of MEPS data and are subject to considerable error.

10 This estimate is based on MEPS data for covered retirees only; the distribution of spending for their dependents might be

different.


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PREMIUM SUBSIDIES Every current proposal includes some form of tax credit or other income-based subsidy for the purchase of coverage in the nongroup (or exchange) market. Generally, these subsidies would not be available to workers or retirees enrolled in an employer plan.11 However, some proposals would allow the subsidy to be used for the worker’s or retiree’s required premium contribution for employer coverage if the premium exceeded some limit, such as 12% of income. Whether the subsidy mechanism would make it advantageous for a particular retiree to shift out of retiree coverage thus depends on several factors: the size of the retiree’s current contribution for employer coverage, the subsidy for which he or she would qualify in the nongroup market, and the potential availability of a subsidy for the employer plan.

Table 8, using 2006 MEPS data, shows how retirees with different employer contribution levels for their current coverage would fare under a simple sliding-scale subsidy scheme. Subsidies would cover 100% of nongroup (or exchange) premiums for families with income below 100% of the federal poverty level (FPL) and would phase down to zero for families with income of 400% of FPL or more. A family could apply the subsidy to employer coverage if the required premium contribution for that coverage was more than 12% of income.

Retirees whose former employers paid the premium and those whose employers paid nothing would be about equally likely to qualify for a subsidy for nongroup coverage. And the average amount of the available subsidy would be about the same regardless of the employer’s contribution level. Those receiving no contribution from their employer would obviously be better off shifting, but so might many of those receiving a partial contribution: for those qualifying for a subsidy, the subsidy would cover an average of 58% of the premium. (As noted earlier, the Kaiser/Hewitt data suggest that employers paying only part of the premium for retirees were covering an average of 56% of premiums.)

11 Some proposals would also bar active workers, but not retirees, who were offered, but did not participate in, an employer plan

meeting minimum standards.

Table 8 Non-Medicare Retirees, by Employer Contribution Policy and Subsidy Eligibility, 2006

Percent of Covered Retirees in Contribution

Class

Percent of Retirees in

Contribution Class Eligible for

Nongroup Subsidy (Income Below 400% of

Poverty)

For Those Eligible, Average

Subsidy as a Percent of Nongroup Premium

Of Those Eligible, Percent That Could Use

Subsidy for Employer Plan

Employer Contributes Full premium 31% 60% 64% NA Part of premium 55% 45% 58% 33% Nothing 13% 60% 59% 79%

Total 100% 52% 61% 29% Source: MEPS 2006.


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Of course this depends both on each specific employer’s policies and on the relative total premiums for coverage inside and outside the group. If, as was suggested above, group coverage might still have some premium advantage, some in the partial contribution category would find it advantageous to stay in the employer group even if the employer contribution was a smaller percentage of the premium than the available nongroup subsidy. But this could be true only in the short range. Given that so many employers have capped their future contributions, the employer contribution will represent a smaller percentage of the premium every year, and a shift to subsidized nongroup coverage would become steadily more attractive.

The potential for coverage shifting is reduced considerably if retirees are allowed to apply a subsidy toward their contribution for employer coverage. Of those required to pay the full premium for employer coverage and with incomes below 400% of poverty, 79% would be able to use the subsidy for their current plan. The potential drawback is that employers with many lower-income retirees would have an incentive to cut back or eliminate their contributions if these could be replaced by public subsidies. The reinsurance program described earlier might reduce this incentive over the short term.

OPTIONS FOR REDUCING CROWD-OUT OF RETIREE COVERAGE

The likelihood of crowd-out, a shift from employer-based retiree coverage to new subsidized nongroup options under health reform, is difficult to assess. Some parts of the health reform proposals under consideration are still too vague for real analysis, and it is uncertain just what effect other components—such as an exchange or public plan—would have on the health insurance marketplace. Still, some amount of replacement seems inevitable. Whether this is actually undesirable will be considered at the conclusion of this report. This section considers some possible steps that would reduce the incentives for employers to drop coverage or for retirees to shift to the nongroup market on their own.

Provide a direct subsidy for employer plans. Under Medicare Part D, there is a risk that employers who have been providing drug coverage as part of their retiree health benefits might have an incentive to drop the drug coverage for Medicare retirees and let them shift to Part D plans, possibly with some assistance with required premiums or cost-sharing. In order to encourage these employers to continue existing benefits, MMA provides subsidies for part of the cost of an employer plan that provides drug coverage at least actuarially equivalent to standard Part D coverage. The subsidy pays 28% of costs incurred by the employer between the Part D deductible and an upper limit for each participant ($6,000 in 2009).12 The cost of the employer subsidy is less than Medicare would have to pay to subsidize coverage of the same enrollees in non-employer Part D plans. In 2006, 82% of large employers accepted the subsidy; only 8% discontinued drug benefits, forcing their retirees into Part D.13 Of employers taking the subsidy, 25% of employers were uncertain about their longer-range plans, but none expected to drop drug coverage.

12 An employer may instead choose to develop its own Part D plan, available exclusively to its retirees, or offer wrap-around drug

coverage, supplementing the Part D benefit. 13 Kaiser/Hewitt.


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A similar subsidy system might encourage employers to go on contributing to the cost of benefits for non-Medicare retirees. The reinsurance program discussed earlier might, on average, provide nearly as large a subsidy as that now offered under Part D. However, employers could not know in advance what portion of their expenses might be reimbursed, and smaller groups might or might not have any cases covered during a given year. A direct subsidy would provide greater certainty. Would it be cost-effective?

Under Part D, Medicare subsidizes two-thirds of the average premium for all enrollees in non-employer Part D plans and a higher share for low-income enrollees; the 28% subsidy for employers is a bargain for the government. A subsidy for non-Medicare retirees would save money only if it were less than the amount that would be spent on premium subsidies for nongroup coverage if the participants in that plan shifted. Given the figures presented in the earlier discussion of premium subsidies, a breakeven subsidy might be about 32% of premiums. But a uniform subsidy would reward employers whose premium contributions were already low and encourage others to reduce their contributions. Instead, the calculation would have to be made plan by plan: what is a particular employer currently contributing? How many of its retirees would qualify for the nongroup subsidy if they shifted? This would be feasible, but cumbersome and possibly subject to gaming. (The computation would be even more complex if, as in some proposals, subsidies were available to individual retirees with a high premium/income ratio.)

Allow employers to purchase retiree coverage through new market mechanisms. Proposals at this point differ on whether the large employers who are most likely to offer retiree health coverage could join a health insurance exchange or public plan. Some would exclude them entirely, while others would admit them only after a phase-in period. One reason for these limits is a concern that these new pooling mechanisms would be most attractive to employers with higher-risk workers; the resulting adverse selection could raise costs for the entire pool. A possible solution would be to admit plans for retirees but not for active workers, and if necessary to allow separate premium rates for participating retiree plans. Whether employers would find this attractive would depend on whether the new arrangements had much lower administrative costs (or paid providers less) than current employer plans.

Prevent individual shifting. Coverage through an exchange or public plan could be closed to retirees who have access to an employer group plan (unless, under the previous option, the employer shifted the whole group). A rule of this kind could be modeled after the current rule for the self-employed health insurance deduction, which makes the deduction available only for people who are not eligible to participate in any subsidized health plan through their own employment or a spouse’s. It would obviously penalize retirees whose former employers are contributing a very small share of the premium (or whose share is dwindling as a result of a cap). In addition, the provision would be difficult to enforce.

Adopt universal health risk adjustment. Most current proposals provide for risk adjustment systems within the exchange but exclude employer plans and any other non-exchange insurers. An alternative would be a single system that transferred funds among all plans, group, and nongroup. This would reduce the likelihood that a group plan confined to retirees would have to charge a higher premium than the community-rated nongroup plans. Probably the play-or-pay schemes envisioned by some current


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proposals’ plans would require a similar mechanism (for active workers as well as retirees). Otherwise, employers’ decisions about whether to continue coverage or pay assessments would depend on the risk profile of their populations. One problem with risk adjustment across market sectors is that it may be difficult to design a system that will work for plans with different benefit packages. Addressing this might require more standardization of benefits than is envisioned by current proposals.

OTHER POTENTIAL ISSUES FOR NON-MEDICARE RETIREES

TAX EXCLUSION FOR EMPLOYER-PROVIDED BENEFITS There have been a variety of proposals to modify the exclusion of the value of employer-provided health benefits from employees’—and perhaps retirees’—taxable income. Some proposals would eliminate the exclusion, while others would set some sort of ceiling, above which employer contributions would be taxable. Proponents of these proposals contend that the current tax subsidy is ill-targeted, providing more assistance to individuals in higher tax brackets. In addition, changes in the exclusion could be a source of offsetting revenue for coverage expansions. Certainly it is an attractive target: the exclusion cost the Treasury $246 billion in 2007: $145 billion in reduced income tax collections and $101 in payroll taxes.14

The rationale for a fixed ceiling is that the exclusion should cover plans providing some average level of benefits and not go to subsidize “Cadillac plans.” The problem is that the cost of employer coverage depends on many factors other than the generosity of benefits, including employee demographic and health characteristics, geographic location, and employer size (because of size-related differences in administrative cost). As a result, an employer that offers leaner benefits or contributes a smaller share of premiums may still have higher expenditures than an employer with a more generous plan.

How would a fixed cap affect contributions for retirees? On average, it might have no effect. Although the average total premium for nonelderly retirees is much higher than that for active workers, employers are contributing a smaller share of the premium for retirees—59% for single retirees in firms with 1,000 or more workers in 2006, compared with 84% of premiums for single workers paid by employers with more than 200 workers in the same year. The result is that large employers contributed $311 a month for retirees and $295 a month for workers.15

Unless a contribution cap were very stringent, it might not affect the average retiree. But it could certainly affect retirees whose firms had more generous contribution policies—including the small number of firms still paying the full premium. The potential exposure for the retirees would be greater if a firm pooled active workers and retirees separately. If a firm contributed, say, 75% of premiums for both active workers and retirees, the

14 U.S. Congress, Joint Committee on Taxation, Tax Expenditures for Health Care, Washington, July 30, 2008 (JCX-66-08).

Uncollected payroll taxes are not traditionally counted as a tax expenditure, because the lost revenue is partially offset by reduced benefit payout in the future.

15 Retiree data from Kaiser/Hewitt. Employee data from Henry J. Kaiser Family Foundation and Health Research and Educational Trust (Kaiser/HRET), Employer Health Benefits: 2006 Annual Survey, Menlo Park, CA, and Chicago, 2006.


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workers might come in below the cap while the retirees exceeded it and faced tax liability. In effect, a uniform cap could directly penalize retirees for their poorer health status.16 However, it probably would not increase the likelihood that retirees would switch to nongroup coverage, because the higher-bracket taxpayers most affected by the cap would not qualify for a nongroup premium subsidy and would still be better off in the employer plan.

One solution to the equity concern would be to set separate caps for active workers and for retirees. Even this would not be entirely adequate, because costs for pre-Medicare retirees are much higher than those for post-Medicare retirees. So three caps would be needed. This would be administratively complex, especially for self-insured employers who may currently be treating workers and retirees as a single pool. Moreover, once one has started down the line of different caps for different populations, it is not clear why there shouldn’t be adjustments for other factors, such as employer size or location.

A case could be made for exempting current retirees from the cap altogether. One of the arguments for the cap is that the employer exclusion gives workers an incentive to choose health insurance (or future retiree health insurance) in place of wages; the cap limits this incentive. Current retirees have no opportunity to negotiate for other compensation in lieu of their former employer’s premium contribution, so a cap is simply a penalty instead of a change in incentives. In addition, enforcing a cap for retiree plans could be difficult. For active workers, employer contributions in excess of a cap would presumably be reported on the workers’ W-2 forms. There is no equivalent reporting mechanism for retirees.17

There has been some discussion of an alternative to modifying the employer exclusion: an excise tax on health insurers who offer policies with premiums exceeding some threshold. While the tax would fall on the insurer and not the employer or employee, the expectation is that the extra cost would be passed on and would thus have the same incentive effects as a ceiling on the tax exclusion.18 The thresholds that have been suggested are quite high and might affect very few retiree plans. In addition, it is not clear how the tax could be applied to self-insured plans, which have no premiums. Although there are no data on the prevalence of self insurance among retiree plans, it is likely that most large employer plans fall into this category.

MEDICARE AND MEDICAID CHANGES Some proposals include Medicare and Medicaid changes that could open enrollment in these programs to certain people with retiree coverage.

16 The alternative cap option, taxing contributions for higher-income plan participants, appears less onerous, but raises the same

equity problems. Contributions for a retiree might exceed the cap, while those for an active worker with the same income would not.

17 Retirees with pension or annuity income receive 1099-R forms; however, these are commonly generated by an entity that is separate from the employer paying for health benefits.

18 Paul Van de Water, An Excise Tax on Insurers Offering High-Cost Plans Can Help Pay for Health Reform, Washington, Center on Budget and Policy Priorities, Aug. 2009.


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Medicare Disabled Waiting Period Some proposals would eliminate the current 24-month waiting period between receipt of Social Security disability benefits and eligibility for Medicare. Some people with retiree coverage would certainly be affected. Of employer-covered retirees under age 62 in 2007, about 8% had Social Security benefits but not Medicare. (Any estimate for such a small population is subject to considerable error.)19 As most employers offering retiree coverage still cover both pre- and post-Medicare retirees, many of those shifted to Medicare under this option might continue to receive supplemental employer coverage.

Medicaid Some proposals would eliminate categorical restrictions on Medicaid eligibility for nonelderly people; everyone with income below a given threshold would be eligible. (Most proposals would also eliminate asset tests, imposing only the income requirements.) If the threshold were set at 100% of the FPL, about 8% of non-Medicare retirees with employer coverage would qualify; again, the estimate is not reliable.20 (Interestingly, there is almost no overlap between this group and the 8% who would benefit from elimination of the Medicare waiting period. Members of the latter group are almost all above poverty, presumably because they have both Social Security and pension income.) Medicaid programs are permitted to buy into available employer coverage by paying the beneficiary’s share of the premium when this is cost-effective; this would probably be the case for many retirees newly qualifying for Medicaid.

CONCLUSION

Whatever health care reforms might be adopted in the near future, employer-provided health benefits for non-Medicare retirees are unlikely to remain an important source of health care funding. Younger workers entering the private sector will surely not have these benefits thirty years from now. State and local governments, faced with pension fund shortfalls and other financial pressures, are also likely to curtail or abandon retiree health benefits in the years ahead. If retiree health benefits are going to disappear fairly rapidly in any event, policymakers might be wise to design a reformed health system on the assumption that retiree benefits will not be a permanent factor.

Still: in the short term, there is a lot of money involved. While no precise data are available, the nearly 5 million non-Medicare enrollees and dependents in retiree plans are probably drawing employer contributions in the range of $15 billion per year. This is a tiny share of all health spending, but it is not negligible in federal budgetary terms. There might be good reason to try to prevent short-term crowding out and at least postpone the replacement of employer dollars with public premium subsidy dollars. Unfortunately, none of the possible measures for doing so seems especially promising; some are cumbersome, while others may raise equity concerns.

19 ASEC 2008. The analysis excludes those aged 62–64 because they might be early Social Security retirees rather than SSDI

recipients. 20 ASEC 2008.


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On balance, it seems sensible to conclude that comprehensive health reform would speed the erosion of retiree benefits. A case could be made that this would be a desirable outcome, if the result would be improved competitiveness for private firms with “legacy” costs and a reduced burden for state and local governments. Finally, of course, the incentives for crowd-out are byproducts of the reforms and subsidies needed to assure that all Americans have access to coverage. Crowd-out of existing benefits for some retirees may be the price must be paid to assist the many other retirees who are currently uninsured or faced with extremely high costs in the nongroup market.

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