As the cost of health care rises and employees pay more for employer-sponsored health insurance, some lower-paid workers will not be able to afford payroll deductions for plan premiums or the out-of-pocket costs for the care they need. It may be time to shake things up and consider tying employees' health plan premiums to their pay.
Today, at most U.S. workplaces, nearly all employees, from the C-suite to the mailroom, pay the same amount for health coverage. An alternative to this traditional structure is to set cost-sharing levels, or tiers, based on employee compensation. That will reduce the amount lower-paid workers must contribute to maintain and use their health coverage, at no additional cost to companies. Higher-paid employees will see a moderate increase in their contributions as they effectively subsidize health coverage for lower-paid workers.
"Most employers don't think about shifting from the current one-size-fits-all approach to using a fixed percent of pay for health insurance coverage, because they have always done it that way," says benefits consultant Gary Kushner, president of Kushner and Co. in Portage, Mich.
But there are several reasons why an employer may want to move to income-based cost-sharing with employees, a model that is rising in popularity.
Communication and Competition
First, asking lower-paid workers to pay a larger percentage of their pay than higher-paid individuals undercuts efforts to help improve employees' financial wellness and stress levels. Second, if cost-sharing is too high, employees may avoid seeking needed care because of high out-of-pocket costs, thereby risking more-serious, long-term health issues.
And for some employers, taking a fresh approach to apportioning health care costs is a competitive strategy. Indeed, organizations that are having difficulty attracting and retaining lower-paid employees may want to consider income-based health care contributions to stand out in the talent marketplace.
The Small Business Association of Michigan (SBAM) is based in Lansing, where it competes for talent against much larger employers, including Michigan State University, that tend to offer more-generous benefits. As a small organization with 27 employees, the association has had to get creative in its benefits offerings.
For nearly 15 years, the SBAM has tied employees' health insurance contributions to their pay, according to Ann Parker, the organization's chief operating officer. Because the SBAM assesses employee contributions as a flat percentage of the total premium, it is much simpler to communicate the total cost of health insurance coverage to employees—and how much of that cost the organization is covering.
The SBAM segments employees into four tiers based on their title or role in the organization, such as clerk, salesperson, vice president and CEO. Parker and her team review the structure annually once they know the cost of health coverage for the coming year. When the organization began using this structure, employees in the lowest tier paid 5 percent of health insurance costs and those in the highest tier paid 12.5 percent. The 2021 structure ranges from 15 percent to 22.5 percent, with employee costs rising 2.5 percentage points from tier to tier.
"We are highlighting that the organization is still taking care of employees" even as the cost of health insurance continues to increase, Parker says. "People tend to be blind to the costs of health insurance, so it's important to give them clear numbers about the value of their plans."
Not Just Premiums
Of course, premiums are just one part of employee health care costs. Some companies have also begun tying all employee cost-sharing to income. JPMorgan Chase & Co. not only sets employee health insurance premium contributions based on income (12 percent of pay for employees making less than $60,000 and more than 25 percent of pay for employees earning above that amount), but it also uses income to set deductibles and co-insurance levels for in-network care. (Deductibles and co-insurance are the same for out-of-network care regardless of how much money an employee earns.)
To set deductible levels, the company uses the same two tiers it uses to set employee premium contributions. A single employee earning less than $60,000 would have a deductible of $1,000 for in-network care, for example, while the in-network deductible for a single employee earning $60,000 or more would be $1,750 for the same plan.
Co-insurance costs for in-network care are segmented using three income tiers. In-network co-insurance levels for family coverage are $2,000 for those earning less than $60,000; $3,000 for those earning $60,000 to $149,999; and $4,500 for those earning $150,000 or more.
Sorting Out the Details
Making the change to income-based cost-sharing should be done carefully and in support of an organization's goals. For example, the required changes can be cost-neutral to the employer if designed to reduce premiums for lower-paid employees and increase them by the same amount for higher-paid employees. In a three-tier structure, the employees in the middle tier would see no change in their premiums. "I have not seen employers use this to collect more in premiums, just how those premium contributions are allocated," Kushner says.
Administrative challenges associated with income-based cost-sharing are surmountable. "Payroll systems can create multiple deductions," Kushner says. Rather than have one or two flat-dollar deductions for health insurance premiums, employers can create deductions for different levels as a percentage of pay. "There is no difficulty doing it," he adds.
Even so, employers should carefully consider whether this is the right approach for them strategically. "This should be a talent conversation, not a health care conversation," advises Julie Stone, managing director with HR consultancy Willis Towers Watson in the New York City area. "It requires time and thought about issues like hiring, turnover, salary levels and talent mobility."
If the shift to premium tiers turns out to be the wrong approach, reverting to the cost-sharing structure will again mean higher contributions for lower-paid employees. Consider the change carefully and be fully committed to it before rolling it out, says Nancy Daas, executive vice president with benefits brokerage firm Hub International in Chicago.
Stone notes that she knows of one employer with income-based cost-sharing that is moving away from that approach. "They want to focus on what they can do to drive health care affordability for everyone," she says. "They're focused on the need to address the underlying issue of cost instead of shifting cost."
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 make the changeover cost-neutral. Limiting the number of tiers also makes the change easier to deal with from an administrative standpoint.
When setting up income-based health care cost-sharing, employers need to decide how to delineate the various levels. For example, some small businesses are able to segment the workforce by title, as the SBAM does. However, the more common approach is to set the levels based on pay ranges.
Determining how many levels to create will depend on several factors, including the number of employees and pay ranges in the compensation structure. "Are there natural break points?" Kushner asks. 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.
Employers can create as many tiers as they want. However, more bands add administrative complexity, Daas says, "because it increases the number of payroll deductions the HR information system must handle."
Will the Structure Really Work?
To make sure the switch from a flat contribution rate is cost-neutral, employers can evaluate how the new structure will work in a real-life situation.
"Look at current contributions versus future contributions under the new structure," Daas suggests. 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 says.
Understanding the financial impact of cost-sharing changes to individual employees and groups is important, Daas adds. If an employer develops a contribution structure that allows lower-paid employees to move from paying 10 percent of their pay for health care coverage to 5 percent of their pay, how does that affect pay for the higher-paid employees whose contributions will be rising?
Questions Daas advises asking include "How many winners and losers will there be among employees?" and "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 in take-home pay. However, if employees are paying $200 or more per month for health care, a sudden, large premium increase could be a problem.
"Contribution strategy is always great in theory," Daas says, "but it can have a big impact in real life."
Is income-based cost-sharing gaining momentum?
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, essentially unchanged from the survey’s 2017 data.
Add in smaller employers, however, and the numbers decline. The Kaiser Family Foundation’s 2020 Employer Health Benefits survey of 1,765 employers looked at the broader category of total cost-sharing and found that only 7 percent of employers with 50 or more employees have any sort of program that reduces cost-sharing for lower-wage workers.
Communicating the Change
Given the magnitude of this type of 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 company leaders are trying to achieve. At the same time, communication to lower-paid employees can ensure that the employer gets credit for making health insurance more affordable for this group, Daas says.
Before implementing and communicating the change, conduct market research to find out what peers and competitors for talent in the same industry or region 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.
Transparency is also important. Stone at Willis Towers Watson advises employers to communicate the entire strategy around these changes and why employees' cost-sharing levels will be changing.
"This should not be a surprise or a secret," she says. If the employer differentiates premiums by income or any other means, such as geography, that should also be clearly communicated. "Employees should also know or be able to find out the impact on their premium contributions if they get married, get a raise or move to a new location."
Managing 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.
Modeling can show how much impact the chosen bands are likely to have as people advance. For example, in a band that covers employees making $30,000 to $50,000 per year, someone making $49,500 who is expecting a pay raise may find that raise has a smaller impact as he or she moves to another band that requires higher health care cost-sharing.
"This could slash the impact of the promotion or raise," says Christopher Calvert, senior vice president with consulting firm Segal in New York City. The change "can be difficult to manage and navigate" without taking steps to neutralize this potential outcome.
Therefore, he suggests, employers should focus on total compensation, not just direct pay. "It's important to make sure the total pay increase is enough to offset any increase in health care contributions," Calvert says. "Or it might make sense to offer a slightly lower increase to keep someone in a lower tier for health care contributions."
For this reason, employers should pay close attention to employees' positions in the cost-sharing structure. "Don't set it and forget it," Kushner says. "Look at the distribution." If there's a cluster of people at the top of a given band's range, for example, that can indicate it's time to examine and possibly update the structure.
Joanne Sammer isa New Jersey-based business and financial writer.
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