What’s Affordable Health Insurance Under the ACA?

Determining whether health plan premiums are affordable under the ACA is anything but straightforward.

By Joanne Sammer Mar 1, 2015
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December Cover 


As a growing tech company in the Washington, D.C., area, Optoro Inc. faces stiff competition for talent. “We have to be pretty competitive on benefits,” says Kathy Penny, the company’s senior director of human resources in Lanham, Md. “We are looking to cover 70 to 80 percent of the health insurance premiums, and we do not budge on that.”

As a result, Optoro found dealing with the affordability requirements under the Affordable Care Act (ACA) for the first time to be a relatively simple matter. Prior to last year’s open enrollment season, the company’s insurance broker conducted affordability testing and determined that some of the company’s plans met the requirements.

Other circumstances also worked in the company’s favor: Optoro offers three health plans, including a relatively low-cost health maintenance organization; company demographics help keep premiums low, since a number of unmarried, younger individuals are among the company’s 175 employees; and employees are generally highly paid.

But Optoro’s experience is not typical. Other employers are likely to have more difficulty once the requirements of the ACA are fully in force in 2016. That’s when employers with 50 or more employees will be required to offer their employees health insurance or pay a penalty. Employers with 100 or more employees must comply with the affordability requirements this year.

Affordability Requirements

“Employers have to offer at least one health plan option that is affordable and provides the minimum value of benefits required under the ACA,” says J.D. Piro, practice leader for Aon Hewitt’s consulting group in Norwalk, Conn. “Affordable” in this case means that the amount each employee pays in annual health plan premiums for single coverage cannot exceed 9.5 percent of that employee’s household income (a figure that will be adjusted annually).

Although the law uses total household income to measure affordability, the requirements relate only to coverage for the employee and not for spouses or dependents.

The Internal Revenue Service (IRS) recognizes that it would be difficult or impossible for an employer to ascertain the household income of every worker. Thus, it allows employers to use one of three so-called safe harbor values for making the affordability calculation:

  • The federal poverty level.
  • W-2 wages.
  • Rate of pay.
Let’s look at an example. Assume that an employer is using one of the wage-based safe harbors. In this case, the lowest-paid employee in the organization makes $20,000 per year. Therefore, to avoid an affordability penalty for any employee, the employer must offer a health plan with employee-paid premiums for single coverage of no more than $1,900 per year ($20,000 × 0.095) or $158.33 per month. If the company does not offer a plan with premiums at or below that amount, the coverage would be deemed unaffordable to certain employees. The employer could be subjected to a penalty for each employee who applies for and receives a subsidy to purchase insurance on a federal- or state-run public health insurance exchange.

Affordability Threshold: 9.5% or 9.56%?

As if affordability compliance was not complicated enough, the IRS recently increased the applicable threshold percentage for purposes of “household income” from 9.5 percent to 9.56 percent to account for increases in health insurance premiums and income growth.

However, the IRS did not increase the percentage used in the safe harbor tests, which remains at 9.5 percent.

Not surprisingly, “this has caused a lot of confusion for employers,” says Daniel Kuperstein, senior vice president of compliance at Corporate Synergies, a benefits consulting company in Mount Laurel, N.J. “While we expect that the IRS will soon apply the increased percentage to the three safe harbors, it has not done so yet.” 

Employers were still waiting for the update when this magazine went to press.

Choosing a Safe Harbor

Deciding which safe harbor to use for calculating affordability will depend on each employer’s unique circumstances.

For Optoro, it was simple. Due to the company’s favorable demographics and choice of plans, any of the safe harbors proved workable. So the company left the choice up to its broker, based on which was easiest to administer.

But many companies will likely find one option clearly preferable based on the nature of their workforce. An employer with many minimum- or low-wage earners might use the rate-of-pay or poverty-level safe harbor, while one with a workforce made up of higher-wage earners might be inclined to use the W-2 safe harbor.

“All of this relates to … being able to get the best available data at a reasonable cost,” Piro says. For example, some income- or wage-related data will have to be compiled on a monthly or weekly basis for employers to be able to track affordability as closely as possible. Obtaining this information in the necessary format may increase administrative costs.

Certainty also factors into the decision. Some employers are using the federal poverty level because it is available early in the year, says Laurence Shulman, a director with consulting company KPMG in Washington, D.C. He adds that “A few are using the rate of pay because it more accurately reflects the employee’s own compensation. Some employers will wait for the W-2, but that information is available later than may be desirable.” With the W-2 safe harbor, if an employee’s compensation drops during the year, an adjustment in the premium may be needed to remain within the affordability requirements.

There are specific tips involved in using each safe harbor as well. For example, when using the rate-of-pay safe harbor, employers do not necessarily need to conduct an analysis of each employee’s compensation. “Employers can assume that hourly employees work 130 hours per month, then figure out the lowest rate of pay that will meet affordability requirements,” suggests Amy Ciepluch, a partner with law firm Quarles & Brady LLP in Milwaukee. “The challenge is that pay rates can change, and employers may have to do these calculations over.”

Finding a Safe Harbor

Here’s what you need to know about the three options the IRS has created for employers to determine affordability.

The federal poverty level
What it is: The amount the U.S. government sets annually to determine eligibility for certain programs and benefits.

Pros: It is readily available early in the year and does not change throughout the year.

Cons: By definition, the figure represents a very low income. In 2015, it is $11,770 for an individual. Thus, employers would have to offer at least one health plan with the required minimum level of coverage that has a monthly employee-paid premium for single coverage of no more than $93.18. (By comparison, if an employer’s lowest-paid employee earns $20,000 per year, “affordable” monthly premiums could be as high as $158.33.)

W-2 wages

What it is: The wages an employee earns for the year as reported in Box 1 of the W-2 tax form.

Pros: It represents the most accurate account of an employee’s income. 

Cons: The information is not available until the end of the calendar year, but the affordability requirement must be calculated monthly. Thus, employers have to make assumptions and projections, which, if incorrect, could lead to penalties.

Employees’ rate of pay

What it is: An amount generally based on an employee’s rate of pay at the beginning of the coverage period. Employers can multiply employees’ lowest hourly rate of pay per month by 130 (hours worked per month) and then take 9.5 percent of that amount to determine affordability.

Pros: It is relatively simple to determine.

Cons: Employers are allowed to make adjustments for an hourly employee only if his or her rate of pay decreases and not if it increases; the latter would allow for higher premiums to meet the affordability threshold.

Complexities in each of the safe harbors have companies hoping for alternatives. “Some employers have expressed interest in a safe harbor based on, for instance, last year’s W-2 or projected earnings for the current year,” Shulman says. “Both these numbers could be determined at a point early enough to adjust rates accordingly.”

The choice of safe harbor may change as employers work through these calculations for the first time. In fact, it would not be surprising for employers to revisit the issue each year, particularly if they are having trouble meeting the affordability requirements, if pay levels in the company change significantly, if there is an influx of new workers, or if the company is involved in a merger or acquisition.

Look for every possible adjustment before calculating affordability. For example, when employer wellness programs reward employees who are not tobacco users, the IRS allows those rewards to be included in affordability calculations—and in some cases, the incentives could lower premiums enough to pass affordability tests. “At least one employer I have worked with had just enough [premium reductions for nonsmokers] to get in under that federal-poverty-line safe harbor when they took nontobacco user incentives into account,” Ciepluch says.

It’s also important to keep in mind there is no requirement to use only one safe harbor. Different segments of the workforce can have premiums tied to different safe harbors.

No matter which safe harbor employers choose, they need to keep an eye on what is most important. “Compliance is not a strategy,” Piro says. “Your compliance approach should fit with your overall health care strategy—providing benefits to attract the best talent possible.”

An Exercise in Risk Management

For some employers, affordability compliance is not an all-or-nothing proposition. At its core, it is an exercise in risk management in which employers calculate their potential exposure to penalties and determine if they are comfortable taking on that risk. Because employers may need to make assumptions and projections when choosing a safe harbor, that choice should depend on each employer’s risk tolerance in case the projections prove incorrect.

“There are employers that do not necessarily feel the need to have affordable coverage for all of their employees,” says Wade Symons, an attorney with benefits consulting company Mercer in Portland, Ore. They have gotten comfortable with the risk of penalties, even if their coverage ends up being deemed unaffordable for certain employees. The rationale is that the risk is worth no longer having to pay premiums (or claims if the employer is self-insured) for those employees or no longer having to take the time to develop a contribution structure that makes coverage affordable for everyone.

If affordability compliance becomes a choice, it should be an informed one. For example, exposure to penalties can occur monthly rather than annually, says Matt Thomas, president of WorkSmart Systems, an HR services provider in Indianapolis. In other words, even if employees have access to affordable coverage on an annual basis, coverage may not be affordable for those employees in certain months due to wage fluctuations and other factors. “If an employee triggers a penalty, this could be an unforeseen liability,” Thomas says. “Know your exposure.”

Employers also need to gauge what they gain from not offering affordable coverage compared to the financial consequences of any resulting penalties. “Employers will not be in trouble with the IRS or breaking any laws as long as they pay the penalty,” Symons says.

By thinking strategically about these issues, employers can identify the approach that’s best for them. “Some employers are completely risk-averse in this regard and don’t want any surprises,” Symons says. Others may bring together HR, finance and other senior managers to discuss and model potential options.

This more-flexible mindset has evolved since the ACA was passed. Initially, many employers worked to avoid penalties at all costs. “Now, rather than making wholesale changes to eligibility or plan design to make it fit within the parameters of the rule, they are saying, ‘Let’s do something else,’ ” Symons says.

Ciepluch notes that a rather complex sequence of events has to occur before penalties kick in. For example, for an employer to face a penalty, an employee must decline the employer’s coverage, go to a public health insurance exchange and qualify for a subsidy that, unlike employer coverage, will be based on the employee’s entire household income.

Tying Premiums to Income?

Income-based premiums are another option for employers. “Tying employee premium contributions to income can also be a good strategy for employers that are not able to subsidize all premiums enough to meet the affordability requirements,” says Steve Wojcik, vice president of public policy for the National Business Group on Health (NBGH) in Washington, D.C.

The NBGH’s Large Employers’ 2015 Health Plan Design Changes Survey of 136 large employers found that 29 percent of those employers will adjust health plan premiums based on an employee’s salary and 7 percent are considering doing so in the future.

The drawbacks to this approach are its complexity and the potential disruptions for employees. After all, if employee pay is variable and changes during the year, employers would have to adjust premium contributions accordingly. “That is not a desirable situation,” Symons says. This approach also “tends to favor the lower-paid and leave the higher-paid employees at a disadvantage, which may make employers reluctant to adopt it.” In other words, if premiums are tied to income, higher-paid employees will pay more than lower-paid employees for the same coverage.

Moving Forward

While the requirements are a lot to take in, it’s important not to get overwhelmed. The first year or two of any compliance effort is fraught with questions and confusion. As employers work through the issues related to affordability, the right approaches and strategies will become clearer, and the IRS may provide more guidance on specific questions such as the impact of an employee’s unpaid or disability leave on affordability. For now, employers will need to treat the process like the work in progress it is.

Joanne Sammer is a New Jersey-based business and financial writer.

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