Managing local government health care costs: The ambiguous incentives of federal health care reform

Recent local government and school district budget deliberations have honed in on deep and often contentious modifications to health care benefits. Many have asked how far local governments will go in reducing benefits now that they have been given greater flexibility to pare down employee health care costs without having to collectively bargain with most unions. These questions likely will continue and become more dynamic with the phasing in of the federal health care reform law.

In 2014, federal law will require all individuals to have health insurance, with new government-subsidized health care exchanges offering an alternative option for small businesses and individuals who are not eligible for Medicare, Medicaid or affordable employer coverage. States can allow large employers to participate in these exchanges in 2017.

How large employers, both public and private, will react to the federal health care reform law is a big unknown. Besides taking advantage of lower cost plans provided through exchanges, some speculate that employers may also consider dropping coverage altogether.

The wild card is a “play or pay” penalty imposed on large employers for not providing affordable employee health care coverage. Large public and private employers who fail to do so will be subject to a $2,000 annual penalty beginning in 2014 for each of their employees, provided that any of their employees have a household income low enough to qualify for a federal subsidy to help pay for coverage within an exchange. Employers offering coverage that pays less than 60% of expenses would face similar penalties, but only for those employees eligible for the federal subsidy. This applies to even seasonal employees that work full-time hours in any given month, a population that currently does not get health coverage in most local governments.

With many local governments paying annual premiums of $20,000 or more for family plans, and picking up more than 80% of plan costs, a $2,000 penalty would be a bargain. Consequently, some argue that many local governments will drop or significantly reduce employer-based coverage.

A recent Urban Institute report challenges this perspective, arguing that for any large employer such a shift would wrongly ignore market realities and the dynamics of worker preferences. While the Institute's report notes that exchanges could better suit some lower-income individuals because of the subsidies for which they are eligible, employers still need to maintain an edge over competitors to retain and attract highly skilled and higher paid employees. Those individuals would not receive subsidies and their share of the exchange plan costs would be approximately 30%, as compared to the typical 15% in employer-based plans.

The report also argues that market competition will force employers who decide to drop health insurance to fully cover the lost benefit with increased wages. On top of that, the employer would still face the $2,000 penalty for each worker.

Do these considerations hold true for local government employers in particular? One factor that has been downplayed is that local governments and their competitors will likely be pressured to contemplate significant changes to employee compensation. Consequently, the market pressure to maintain health care benefits in order to remain competitive may be diminished as all employers continue to recalibrate compensation. Nevertheless, a key question is how local governments will balance the reality of restricted resources and the need to preserve critical public services with their equally compelling need to attract and retain quality workers.