Income-Based Premiums Help Make Health Care Affordable

As employees pay more for employer-sponsored health coverage, lower-paid workers may not be able to afford payroll deductions for plan premiums. It may be time to shake things up and consider tying premium contributions to employees' earnings by incorporating premium tiers into health plans.

Now, all employees, from the C-suite to the mailroom, pay the same amount for health coverage at most U.S. workplaces. An alternative to this structure is to set premium levels based on employee compensation. This allows employers to reduce the amount lower-paid employees must contribute to maintain their health coverage. Higher-paid employees will see a moderate increase in their contributions as they effectively subsidize health coverage for lower-paid workers.

"This is a good and logical way to price health care for employees," said Christopher Calvert, senior vice president with HR consulting firm Segal in New York City.

Commitment Required

A 2019 survey of 610 large employers by HR consultancy Willis Towers Watson found that 27 percent of employers were planning to base employee health care contributions on employee pay levels in 2020, and 34 percent were considering doing so in 2021.

The difficulty in shifting to income-based premium tiers is one reason why most employers have not adopted this approach. "There are winners and losers," said Nancy Daas, executive vice president with benefits brokerage firm Hub International in Chicago.

For example, if the shift to premium tiers results in administrative complexity such that an organization decides to revert to a flat-contribution rate, that reversion will again mean higher contributions for lower-paid employees. Consider the change carefully and be fully committed to it before rolling it out, Daas advised.

Below are key questions employers should answer before adopting premium tiers.

How will you structure it?

While employers could assess income-based premium contributions as a flat percentage of pay, most create multiple contribution tiers to ensure fairness and to make the changeover cost-neutral. Limiting the number of tiers also makes the change easier to deal with from an administrative standpoint.

The structure for income-based premiums is relatively straightforward. Employers generally subdivide employees by income and charge a set premium for that band or tier. While employers have used two to six bands, the most common approach is to use three or four.

More bands add administrative complexity "because it increases the number of payroll deductions the HR information system must handle," said Daas.

In this approach, the tiers might cover employees earning $35,000 or less, those earning between $35,000 and $50,000, and those with incomes above $50,000. "Some employers also add a fourth tier for very highly paid employees," said Calvert.

To avoid unnecessary complexity while also meeting the unique needs of the workforce, Daas recommended that employers focus on grouping employees based on pay alone and not on department, position or level. Otherwise, there may not be enough of a distribution across the tiers to make the structure viable.

Will the structure work in reality?

To make sure the switch from a flat-contribution rate is cost-neutral, employers can model and evaluate how the new structure will work in a real-life situation.

"Look at current contributions versus future contributions under the new structure," suggested Daas. What is the resulting total for all employee contributions? "You want to find out if there are any unintended consequences that run up employer costs or adversely impact employees," she said.

Understanding the financial impact of premium changes to individual employees and groups is important, she added. If an employer develops a contribution structure that allows lower-paid employees to move from paying 2 percent of their pay for health care coverage to 1 percent of their pay, how does that affect pay for the higher-paid employees whose contributions will be rising?

Daas advised asking, "How many winners and losers will there be among employees? Is this reasonable, and will higher-paid employees be willing to absorb the resulting X percent increase in health care contributions?"

If contributions start at a relatively low level, a 50 percent rise for higher-paid employees may not make much of a difference. However, if employees are paying $200 or more per month for health care, a sudden, large increase could be a problem.

"Contribution strategy is always great in theory, but it can have a big impact in real life," Daas said.

[SHRM members-only HR Q&A: Are employers allowed to offer different benefits to different employees and to charge more for the same benefit, or is this a discriminatory practice?]

Are you prepared to clearly communicate the change?

Given the magnitude of this plan adjustment, communication is critical. Employers need to carefully explain and build their case for income-based health care contributions so that higher-paid employees understand what the employer is trying to achieve. At the same time, communication to lower-paid employees can ensure that the employer gets credit for taking steps to make health insurance more affordable for this population, Daas said.

Before implementing and communicating this change, it is a good idea to conduct market research to find out what peers and competitors for talent in the same industry or geography are doing. This does not have to be limited to companies that use income-based premium tiers for health insurance. The key is to get a clear sense of how much employees at competing companies pay for coverage.  

This information can also be helpful when communicating about the change.

How will you manage promotions and pay raises?

The final and perhaps most critical question is how to handle salary increases and promotions that cause employees to move into the next income tier with a higher health care premium level. "This could slash the impact of the promotion or raise," Calvert said, and the change "can be difficult to manage and navigate" without taking steps to neutralize this potential situation. Therefore, he suggested that employers focus on total compensation, not just direct pay.

"It is important to make sure the total pay increase is enough to offset any increase in health care contributions," Calvert said. "Or it might make sense to offer a slightly lower increase to keep someone in a lower tier for health care contributions."

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

Related SHRM Articles:

Tying Health Plan Premiums to Salary Can Aid Lower-Paid Earners, SHRM Online, October 2017

Earn Less, Pay Less: Salary-Based Premiums, HR Magazine, March 2012

General Electric Medical Insurance Contributions Based on Wage Range, HR Magazine, March 2012

Are Health Premium Tiers a Good Idea?, SHRM Online, January 2012

Salary-Based Health Care Premiums at University of California, SHRM Online, October 2008