Cutting The Gordian Knot Of Employee Health Care Benefits And Costs: A Corporate Model Built On Employee Choice

President Joe Biden’s promise to give every American access to affordable health insurance is well-intentioned, but his plan’s policy elements—a public option, a permanent expanded tax credit—require congressional approval and would expend significant political and taxpayer capital. We offer an alternative approach that could trigger substantial improvements in health care coverage, cost, and quality; that would pay for itself; and would require only executive rulemaking.

Our proposal would unleash the power of large corporations, the biggest purchasers of health care. They currently spend $962 billion to purchase health care insurance on behalf of their employees. But because they offer their employees only a modest number of insurance options, their dollars are not impacting the market—to control costs, improve quality, and enable access—as they should. If employers instead gave their employees pre-tax employer-sponsored insurance (ESI) cash to purchase their own Affordable Care Act (ACA)-compliant insurance, and save any residual as after-tax income, the market would respond vigorously to these employees’ preferences by offering more innovative, cost-effective plans, along with improved transparency and the navigational aids needed to choose them.

This powerful change could be achieved by expanding a little-known rule that allows using health reimbursement accounts (HRAs) to purchase insurance. The key insight is that ESI has offered plans that are more expensive/different from what most employees prefer, cutting into the take-home pay of lower- and middle-class employees and constraining innovative offerings. Some modest regulatory changes to how HRAs can be used would put control of these ESI dollars directly into the hands of workers. Because health insurance premiums are generally not tied to income, the benefits of these changes would accrue especially to those with lower incomes.

The Costly Shortcomings Of ESI

Health insurance was never intended to be tied to employment. However, because of an expedient decision to allow employers to offer health insurance as an untaxed benefit and thus avoid World War II wage controls, it is now nearly impossible to separate the two. ESI has some benefits—it enables convenient risk pooling in large firms, for example—but recent trends are hard to defend, as prices for health coverage remain high while choices remain few. Furthermore, from 2014 through 2019, health insurance premiums for corporate family plans increased by 22 percent, vastly exceeding overall inflation, 8 percent, and the growth workers’ earnings, 14 percent. Meanwhile, in 2019, only one-fifth of insured workers in all firms had a choice of more than two plans, and 36 percent had no choice.

These two trends—increasing prices and inadequate choice—are likely related. At the very least, greater choice of insurers has been shown to put price pressure on insurers. Adding a single insurer offering to the ACA’s health exchange plans in 2014, for example, reduced premiums by 4.5 percent on average. Premiums in these exchanges were 50 percent higher, on average, in areas with only one insurer than those with more than two insurers. Similarly, in the employer market for health insurance, premiums in average markets were approximately 7 percentage points higher due to increases in local concentration of health insurers from 1998 through 2000.

Research also indicates that employees with ESI would meaningfully benefit from receiving a broad set of health insurance choices. One study, for example, found that the median employee would be willing to forgo roughly 16 percent of her subsidy for the right to apply the remainder to any plan she chooses. Another study found that when workers are given choices among competing health plans, they exhibit the price sensitivity that consumers display elsewhere.

Unfortunately, few CEOs have shown direct interest in health insurance selection, despite the high cost of coverage and its importance to their employees, and most senior company leaders fail to think seriously about employee health and health benefits. Instead, they delegate this function to their Human Resource (HR) staff, who in turn select a plan that is acceptable to the CEO’s family—a stratagem known as “CEO’s Partner’s Plan” because it is designed to limit complaints from the partner. But the CEO’s plan is likely not one that a woman who heads a family and earns $50,000 a year would choose.

HR departments also rely heavily on third-party administrators that are often owned by an insurance firm. These intermediaries may well be incentivized to restrict the plans to the offerings of their owner. As one expert noted, “self-funding administrators…tend to be still very much under the wing of the parent insurance company.”

As firms sought to control ESI costs, employees were required to contribute a growing share of insurance costs. From 2009 to 2019, employees’ share of health insurance premiums grew from 26 percent to 30 percent, and average annual deductibles have doubled. Thirty percent of covered employees were in plans with deductibles averaging a hefty $4,673–$5,335 for various family high-deductible health plans. Underinsurance grew as well, with 28 percent of workers lacking complete financial protection from illness.

The diversion of employee money to pay for health insurance is a little-discussed factor in stagnant wages among wage-earning employees. Rising premiums hit lower-income employees especially hard and exacerbate income inequality because employee contributions for health insurance premiums are typically not adjusted for income. Premium increases may also have caused a decrease in the number of lower-income employees’ who take up an employer’s offer of health insurance.

A Reform Proposal

We offer an easily implementable proposal: Instead of employers purchasing insurance plans on their employees’ behalf, they should give their employees pre-tax cash in an HRA, with which employees can purchase ACA-compliant plans. The Obama administration’s Internal Revenue Service ruling stated that any finite distribution to an HRA—even one used to purchase an ACA-compliant insurance plan—would violate the ACA’s annual dollar limit prohibition. But in June 2019, a revised rule permitted employers to offer an “Individual Coverage HRA [ICHRA],” that employees could use for insurance premiums.

Unfortunately, the revised rule reaches few US employees because it only allows the purchase of individual health plans rather than group plans. Individual plans are sold on a “full-risk” basis, meaning that the insurers bear the underwriting risk of health costs, whereas large employers with group plans mostly carry the risk themselves. (These arrangements are called “self-insured” or “self- funded” plans.) Since full-risk insurance is priced higher than self-insured plans, the large employers that provide the majority of ESI are unlikely to offer the ICHRAs. Accordingly, the Treasury Department estimated that fewer than one million people would benefit from the rule in 2020 and only 10 million would benefit by 2028. This is a small share of the population, the market, and the problem.

This shortcoming could be easily remedied by expanding the rule to allow self-insured employers to issue tax-free ESI funds in HRAs; employees would then be allowed to purchase from an expanded menu of group plans offered through the employer. This arrangement would allow the six in 10 employees who receive health insurance through self-insured employers to purchase their health insurance more directly from a wider choice of plans and to weigh the a plan’s premiums with its other cost burdens (since HRA money can also be used for health insurance deductibles, coinsurance and copayments, and other medical expenses). HRAs make explicit an employer’s contribution to employee health insurance, thereby highlighting a tradeoff between pre-tax health insurance dollars against after-tax income. Once employees took full control of their health care dollars and directly observe the opportunity to economize, they might additionally demand a wider selection of plans.

One necessary accommodation would be to price plans with a “holdback,” to assure that the self-insured employer retains sufficient ESI funds to pay for the expenses of high-cost employees. The holdback represents the employee’s contribution to ensuring that the employer’s health costs are covered, thus stabilizing the risk pool.

Even with such a holdback, many employees are likely to benefit by finding more attractive insurance options than those that their HR department offers. And when the employees can economize, other benefits accrue. We constructed a simulation with 2018 data that estimates that applying these reforms to all US workers receiving ESI would increase annual after-tax worker income by $101–$252 billion and annual federal tax revenue by $39–$163 billion. Moreover, increases in after-tax income accrue disproportionately to lower-income employees. And because employees buy lower-cost health insurance, total simulated medical care expenses (based on the ACA’s medical-loss ratio) decline commensurately by 7.3–25.1 percent, sums that would exceed hundreds of billions of dollars.

The logic underlying these benefits is simple. Employees, who reflect a diverse set of economic priorities and various preferences, would choose for themselves between pre-tax dollars for health insurance and after-tax take-home pay. And with the addition of hundreds of millions of new purchasers of health insurance, many of whom exhibit a range of greater price sensitivity and cost consciousness than most HR managers who currently purchase plans in bulk can reflect, insurance markets would respond to meet those preferences. In short, this modest change to how ESI is purchased would unleash the consumer choice and insurer competition that currently does not exist.

The shift we propose in purchasing health insurance is similar to changes in how employed individuals saved for retirement. Americans moved from relying on defined benefit plans, in which employers invested their employees’ pension funds, to defined contribution ones, in which individuals invested these funds. The shift to consumer-controlled, direct contribution plans stimulated substantial growth in the availability, diversity, and cost of investment options for workers. Many invested in mutual funds. By 2019, the funds held $25.7 trillion in assets, growing from $48 billion in 1970. Fund expenses and management fees continued to drop, and the period also saw a substantial increase in expert sources of financial investment advice.

When investment decisions were transferred into the hands of individual employees, the market responded. New investment vehicles and educational resources emerged, and the market’s quality improved. We would expect the market for health insurance to respond similarly under our proposal. If the adoption rate followed that of defined contribution pension plans, employer-purchased health insurance plans would in five years constitute 70 percent of all ESI plans and then gradually increase over the next 35 years to 95 percent of the market.

Complementing Other Policy Initiatives

Although we believe our proposal warrants support on its own, particularly because its implementation requires little more than tweaking a recently enacted federal rule, expanding ICHRAs would complement a modified public option. To ensure that enrollees in a public option would not increase Medicare’s underfunded liability, these plans would be run by private insurers on a pay-as-you-go basis, though benefiting from Medicare’s lower payment rates to providers.

Employers who choose to add this lower-cost public option to the plans available would put downward price pressure on other commercial insurance in the Marketplace and help cover many of those currently uninsured, including the many uninsured employed in small- and medium-size enterprises. In a prior Health Affairs Blog post, Regina Herzlinger and colleagues estimated that the average public option premium would likely be substantially below that of the ACA’s most popular silver plan and of small- and medium-size enterprises employees by about $3,600 (pre-COVID-19 data). It would also lower Medicare’s average medical care expenditures by newly including these enrollees, whose average medical expenses are lower than those of the elderly. In short, the combination could be good for employees and good for Medicare. (Employers would be prohibited by rule from sending only their sickest employees into these public options.)

Consumer Protections

Some warn of choice overload, but the empirical evidence is mixed. However, since insurance markets lack transparency and would reach stable equilibria only if workers could choose wisely, consumer supports would be a necessary element of our proposal:

• Following the example of defined contribution investment plans, insurance plans would be subject to enhanced transparency requirements so employees can make fully informed selections.
• Employers would also be required to disclose their employees’ financial tradeoffs in selecting alternative plans, clearly illustrating the impact of different choices on after-tax income and coverage.

These safeguards echo the ACA’s funding of navigators and other services to assist individuals purchasing ACA plans. Efforts to assist individuals purchasing ACA plans and employees purchasing plans with ICHRAs should reinforce each other.

Summing Up

The plan outlined above would enlarge health plan enrollment; control costs; raise after-tax incomes, especially for lower-income workers; and increase tax revenues, at no additional employer or public cost. Although we are not politicians, we think that our plan would meet today’s political demands. It enables informed workers to purchase their own insurance, relies on market mechanisms, imparts no additional entitlements, and requires no legislative action. Perhaps most of all, it injects significant competition into a somnolent insurance market.

We are now confronting perhaps the gravest costs of linking health insurance to employment. Among people who said they or a spouse or partner lost a job or were furloughed because of the COVID-19 pandemic, two in five had health coverage through the affected job; and among those who previously had coverage through an affected job, one in five said they or a spouse or partner were now uninsured. Although any kind of health reform is hard, it will be harder to emerge from a pandemic if more people are uninsured because of job loss.