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The following is provided by First Niagara Benefits Consulting through its technology provider, bswift Exchange Solutions.

Please contact First Niagara Benefits Consulting for all your Private Exchange questions; 1-855-265-3615 Exchange@fnrm.com

This publication is for informational purposes only. Any content relating to the tax or legal status of the products discussed herein is not intended to provide tax or legal advice to the reader or to be used by anyone to provide such advice. Readers are urged to seek tax and legal advice based on their specific circumstances from independent tax and legal professionals. Insurance products are available through First Niagara Risk Management, Inc. a wholly-owned subsidiary of First Niagara Bank, N.A., and a licensed insurance broker and agent. Insurance policies are obligations of the insurers that issue the policies. Insurance products may not be available in all states. The content of this article concerning future events, trends or developments represents the opinion of the author based on current expectations and certain assumptions, and is therefore subject to risks and uncertainties.

Emerging Health Insurance Exchange Models The Intersection of Public and Private Exchanges Donald W. Garlitz, Executive Director, bswift Exchange Solutions

10 S. Riverside Plaza, Suite 1100 | Chicago, Illinois 60606 877-9-BSWIFT or 312-261-5750 info@bswift.com | www.bswift.com

Emerging Health Insurance Exchange Models The Intersection of Public and Private Exchanges Donald W. Garlitz, Executive Director, bswift Exchange Solutions

Executive Summary Health insurance markets are on the verge of unprecedented change. Rules and regulations promulgated in accordance with the Patient Protection and Affordable Care Act (ACA) will create the conditions for public and private health insurance exchanges (HIX) to expand and thrive in 2014 and beyond. This paper supports the following conclusions related to health insurance exchanges: } Multiple-insurer participation (“farmers’ market”) will be available in a variety of exchange models including public

American Health Benefit Exchange (AHBE) and Small Business Health Options Program (SHOP) exchanges, private platforms that target consumers directly or through employers with individual products, and private platforms that target employers with a variety of group products. } Single-insurer arrangements (“roadside stand”) will lure some traditional employer-based group plans onto platforms that

administer group or individual medical products, ancillary products, and possibly certain HR services or payroll integration. } The continued appeal of small group products will depend heavily on pricing differentials between community rated

individual plans and community rated small group plans. State-based decisions to either merge or segregate the individual and small group markets will determine the long-term appeal of group insurance for smaller employers in those states. The viability of large and small employer health plan strategies involving the use of individual products rather than group products will depend on this state-based decision, complicating the option for multi-state employers. } Employers with no group health plan may sponsor pre-tax withholding for individual products to accommodate the tax

needs of the corporation and employees that do not buy in the AHBE. Some middle income individuals that technically qualify for premium tax credits in the AHBE may learn that buying unsubsidized pre-tax coverage outside the AHBE will represent a better financial decision than buying subsidized AHBE coverage after tax. } Low wage employers will likely either: 1) maintain group medical insurance, funded to the employee-only rate,

2) reduce full time low wage positions to part-time to make low wage workers ineligible for group medical insurance, or 3) eliminate group medical insurance. The pluses and minuses of each approach are discussed. Low wage workers with dependents may intentionally seek employment with part-time positions or with companies where no group health plan is offered in order to remain eligible for federally subsidized family coverage in the AHBE. } Some large employers may experiment with a farmers’ market-style private exchange, although sponsors must deliver

the critical mass needed to make these arrangements attractive to insurers, and carefully navigate the creation of agreeable risk adjusting mechanisms without violating anti-trust regulations. } Many low income wage earners will find that family insurance coverage is significantly more affordable in the AHBE than

in the group plan of the low wage employer.

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Emerging Health Insurance Exchange Models: The Intersection of Public and Private Exchanges

} Exchanges will ideally have three common characteristics: 1) participation by multiple insurance carriers, 2) a wide

selection of product offerings with respect to plan design and consumer out-of-pocket risk, and 3) premium processing capabilities. Alternatives lacking one or more of these characteristics may still appeal to certain constituencies. } Federal rules will restrict all small group plan designs to lower deductibles only, and catastrophic plans that offer young

individuals a high deductible, no co-insurance, and lower premiums, will be available in the individual market but not the small group market. Both facts will likely influence many small employers to disband group coverage in states where individual pricing is the same as small group pricing for like plan designs. } The AHBE will attract many low wage individuals with the promise of federal dollars in the form of premium tax credits

and cost-sharing subsidies. Consumers that do not receive AHBE tax credits/subsidies and who seek individual products may choose to buy them outside the public AHBE because individual AHBE plan premiums are not permitted pre-tax status under section 125 cafeteria plans. } Most small employers will not benefit significantly from small business tax credits offered in the small group market

including the SHOP exchange. Small group farmers’ market private exchanges may come together in some states to offer a different mix of insurers and/or products than are available in the public SHOP exchange. } Small employers with healthy risk profiles may consider self-funding to beat the community rates of fully insured markets,

or may explore professional employer organization (PEO) alternatives in search of lower health insurance rates. Some PEO health plans may continue to try and medically screen prospective clients before allowing them as clients in 2014 and beyond. } Farmers’ market exchanges will likely create the environment where insurance brokers and consultants act as “buyer’s

agents” rather than “seller’s agents.” Broker-driven exchanges may allow producers to continue providing employer advisement while maintaining reasonable recurring revenue streams.

Introduction In the wake of state-based initiatives to create health insurance exchanges in Massachusetts and Utah, and in the context of public exchanges coming under federal law, market makers throughout the U.S. are developing models for both public and private exchanges. Significant opportunity surrounds the creation of private exchanges to operate in parallel with the public exchanges required under the Affordable Care Act. Insurers, brokers, employers, benefit administrators, financial services providers and large retailers are all considering how they might capitalize on the growing interest in exchanges, and protect or grow their markets as exchange models emerge. The success of these new distribution models will depend largely on the ability to deliver meaningful and improved value to employers and consumers.

The Farmers’ Market vs. The Roadside Stand The traditional farmers’ market brings together many produce growers, each with one or more types of produce to offer. This farmers’ market idea has been effectively modeled for health insurance by the Utah Health Exchange, which was established to administer employer-based defined contribution group health plans. The Utah Health Exchange offers over 100 health plans from multiple insurers. Insurers, brokers, and employers are contemplating private exchanges that offer products from only one insurer. Insurers may choose to populate these single-insurer offerings with either individual or group product, and some may do both. Whether these one-insurer arrangements are in fact exchanges or simply re-branded traditional offerings is a matter of opinion, but clearly a single-insurer exchange is more akin to a roadside stand that sells produce from a single farm, rather than a more comprehensive farmers’ market. Both farmers’ market and roadside stand models are emerging for health insurance exchanges, and each may deliver an important value to certain constituencies.

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Apples-to-Apples vs. Cornucopia Whether the consumer goes to a multiple-insurer “farmers’ market” or a single-insurer “roadside stand,” the consumer will find the greatest value in a market that offers a variety of products—metaphorically, the “cornucopia” with many types of produce rather than a more limited selection such as fruit only, or more narrowly, apples only. The risk tolerance of consumers varies, and an exchange will maximize its appeal when available plan designs are broadly spread in actuarial value and out-ofpocket risk. This concept has been practically implemented in the Utah Health Exchange, where consumers have collectively chosen over 100 different plan designs as of January 2012.1 The ACA restricts deductible offerings for small groups beginning in 2014. Single deductibles greater than $2,000 will be prohibited in small group plans (inside or outside of exchanges) unless the employer offers a health reimbursement arrangement (HRA) or health flexible spending account (FSA) with employer funding that covers any portion of deductible that exceeds this maximum; health savings account contributions will not satisfy the requirement to fill any gap between the actual deductible and the $2,000 limit.2 Furthermore, lower cost “catastrophic” plans that may have high deductibles and no co-insurance will be available only to individuals under age 30 and will not be available in the small group market.3

An exchange will maximize its appeal when available plan designs are broadly spread in actuarial value and out-of-pocket risk. This concept has been practically implemented in the Utah Health Exchange, where consumers have collectively chosen over 100 different plan designs as of January 2012. As a result, small group exchanges will be comparable to produce markets that offer only fruits or only vegetables; some choice will be available, but not enough to satisfy the demand of multitudes of consumers. Private exchanges that focus on individual products will appeal to consumers seeking more plan design flexibility than federal rules permit in small group products. Insurers will certainly look to distribute their products through multiple channels, possibly including both public and private exchanges. Some private exchange sponsors may try to create value and attract business by negotiating with insurers to offer unique products only available in that particular exchange, and insurers will undoubtedly consider offering unique products when operating a roadside stand.

The Flow of Money The value proposition of an exchange will be judged in part by its ability to process premium payments efficiently. Many exchanges will connect the consumer to a funding source. Whether health insurance dollars come from an employer, a public agency, or another private institution, the exchange may track available funds from each source, collect any required contribution from the individual, and remit the premium to the appropriate insurer. Online shopping services or premium quoting engines are becoming more common in today’s market. While some of these arrangements will market their services as a “private exchange,” it will be important to distinguish the “business to consumer” operations where the consumer pays premium directly to the insurer from the “business to business to consumer” models that involve third-party payment administration suitable for employer-facing solutions. Any time third-party payment administration is involved, the exchange will need to keep track of complex transactions such as overlapping enrollments (e.g., simultaneously carrying out a new hire enrollment effective in the current year and an open enrollment effective the following year) and life status event changes (such as marriage, birth or adoption), and properly track the flow of money as each of these changes is executed. These procedures are further complicated when the consumer has the right to switch from plan to plan or insurer to insurer when life status events occur. Given the expected churn of some consumers between the AHBE, Medicaid, SHOP, private exchanges and/or various other commercial solutions, keeping track of the money will be a tall order.

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Pre-tax payroll deductions by employers create a need for ongoing eligibility and enrollment administration even where individually owned policies are involved. For example, if an employee owns an individual policy funded by pre-tax payroll withholding, the employee has a need to communicate coverage and cost changes back and forth with the insurer and with the payroll department or payroll system of the employer whenever enrollment changes occur. Life status event changes such as marriage, birth, or relocating outside the service area of a health plan will make administration difficult unless handled by a third party, particularly when the employer is receiving a single consolidated bill of employees covered on individual products. Public and private exchanges that target employer groups will need to address year-round administrative needs of employers whether focusing on group products or individual products.

The Monopoly and Limitations of Federally Approved Public Exchanges Federally approved exchanges will serve two markets beginning in 2014. First, the AHBE will offer individual products, and will be the exclusive arrangement where qualified individuals may receive refundable tax credits (to help cover monthly premiums) and cost-sharing subsidies (assistance paying deductibles, co-pays and co-insurance). Individual and small group products will be classified into bronze, silver, gold or platinum “metal” groupings based on actuarial value beginning in 2014, including the “qualified health plans” (QHP) offered in the public exchanges. The AHBE will capture millions of new consumers seeking federal health care assistance, but it is unlikely to attract many non-subsidized consumers since the ACA excludes individual plans sold in the AHBE from pre-tax advantage under section 125 cafeteria plans.4 The second federally approved exchange is the SHOP, which is meant to appeal to small businesses (size 1-100) as a group insurance solution by offering temporary small business tax credits, The AHBE is unlikely to attract and by promoting large group buying power to small employers. SHOP exchanges could be popular vehicles for implementing the many non-subsidized defined contribution approach to health care for small employers consumers since the ACA if the state's SHOP approach accommodates it, although the availability of small business tax credits and the suggestion of excludes plans sold in the lower premiums have probably been oversold. The remarkably low AHBE from pre-tax advantage. volume of claimants for the current tax credits (10% of expected volume in 2010)5 validates the hypothesis that this tax incentive will mainly benefit micro-employers (fewer than 10 employees) with low wage earners (under $25,000 average annual income). As employer size or average employee income increases, the credits quickly phase out. Beginning in 2014, small business tax credits will be available for a maximum of two consecutive years to any given employer, and will be available both inside and outside public exchanges if the employer meets certain minimum contribution requirements.6 As a result, many small employers will not join the SHOP based strictly on small business tax credits. SHOP exchange QHPs will be priced comparably to non-SHOP small group plans of like plan design and provider network. The adjusted community rating model of the ACA will span the entire individual or small group block of each insurer whether inside or outside an exchange, which will smooth out pricing variations inside vs. outside any exchange for that insurer (see section “Finding the Best Deal: Community Rating vs. Volume Discounting”). Regulation will force the blending of pricing, but will not prevent insurers from seeking lower risk populations. ACA rating regulations do not restrict an insurer from choosing to offer coverage only in certain segments of the market where the insurer believes risk to be more favorable.7 If an insurer believes risk to be lower inside or outside an exchange, the insurer may offer coverage only in one or the other. Proposed federal regulations consider four possible approaches that states may make available for employers adopting the SHOP exchange.8 The state could allow any of the following: 1) offer employees access to any QHP from any metal class (consistent with the Utah Health Exchange farmers’ market approach), 2) restrict employee choice to one metal class only, 3) restrict employee choice to only certain specified plans within a metal class, or 4) restrict employee choice to one specific

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health plan in a “one-size-fits-all” approach (consistent with the Business Express offering of the Massachusetts Health Connector). Each state’s approach on this issue will influence how many farmers’ market-style small group private exchanges may develop in the state.

Finding the Best Deal: Community Rating vs. Volume Discounting Federal messaging is leading consumers to expect large group buying power from public exchanges. Small employers and individual buyers will quickly realize that community rating is not the same as volume discounting. The concept of obtaining lower prices by “buying in bulk” may seem intuitive to consumers, but the opposite is likely to occur for the majority of consumers currently insured in individual or small group products. Over 40 states currently allow medical underwriting for individual products, which usually involves collecting self-reported health risk information from individuals. In today’s market, premium rates for medically underwritten plans are most commonly developed based on rate-banding, which allows an individual’s rates to vary within a regulated range based on how much risk the person represents. Less healthy individuals are often denied coverage in these medically underwritten markets, yet these less healthy people will be accepted into the individual product risk pool of each insurer under guaranteed issue requirements of the ACA beginning in 2014. Individual product premium rates in 2014 will be based on an adjusted community rate where the sick and the healthy pay the same rates except for variables allowed for age, family size, rating area (such as ZIP code), and tobacco use.9 Since the entry of less healthy people into each insurer’s risk pool will raise the average cost per person in the existing pool, adjusted community rates will be higher in 2014 than current rates for medically underwritten plans. Half or more of small groups will experience rate increases in 2014 for the same reason, which will be in addition to the rate increases due to inflationary trends. The new state-wide benchmark for pricing competition for any given plan design will be the adjusted community rate of the individual market product. This individual product rate will be used by employers as the basis for comparison when employers consider the value of continuing to sponsor group plans. The adjusted community rate will be developed by each insurer based on a common risk pool including all of that insurer’s plans both inside and outside the exchange. As currently uninsured individuals begin to enroll in federally subsidized individual products in the AHBE, pent-up demand for services will drive higher than normal short-term utilization in the individual product market, which will affect individual product pricing.

The concept of obtaining lower prices by "buying in bulk" may seem intuitive to consumers, but the opposite is likely to occur. If an individual or small group exchange happens by luck or design to attract better than average risk, some of the financial advantage that might accrue to the insurer will be pulled away based on mandatory participation in risk adjustment and risk corridor arrangements. These programs will support insurers that get higher risk individuals, and will apply both inside and outside exchanges and in both the individual and small group markets. Insurers will also be required to give consumers rebates if medical loss ratios are not sufficient to meet regulatory guidelines under the ACA.10 By regulation, individual or small group rates for any given product will not vary inside vs. outside a public exchange.11

Farmers’ Market vs. Roadside Stand Private Exchanges Insurers will carefully consider how many new markets they have the bandwidth to engage. Many insurers are expected to have interest in the AHBE due to the expected volume driven by the availability of federal premium tax credits and cost-sharing subsidies. In any given small group market, some insurers will engage in the public SHOP exchange, while others may remain open to participating in a private farmers’ market-style exchange similar to HealthPass New York or the Connecticut Business and Industry Association Health Connections. Insurers that choose to adapt their systems to interface with one type of exchange may desire to spread their products as broadly as possible by engaging in other exchanges with similar technical and functional requirements. Insurer concerns over risk selection in small group markets will be partly mitigated by mandatory risk adjustment that will apply to all individual and small group markets (except for grandfathered plans).12

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Emerging Health Insurance Exchange Models: The Intersection of Public and Private Exchanges

Private exchanges sponsored by non-insurers and that distribute individual products will probably follow the farmers’ market approach, since they will be competing to some degree with the AHBE which is a farmers’ market. Insurers should have no major risk-based concern about having their individual products offered side-by-side with competitors since risk selection in the individual product market is accounted for in the adjusted community rate and mitigated by risk adjustment. Private exchanges targeting the individual product markets are already emerging, and insurers will no doubt have concern about fair representation in the marketing practices of private exchanges owned or operated by competitors. Insurers are considering how to position their products for success, and one approach that will certainly have appeal in both small and large group markets is the single-insurer roadside stand. This type of arrangement will be very similar to traditional group insurance offerings, except that the product breadth available to any given group may be expanded. When coupled with a capable administrative platform, the insurer could go to market offering both medical and ancillary insurance on a single platform, which could offer additional services such as human resource information capability and payroll integration, which would be novel to most small groups. These additional insurer-sponsored services offer the prospect of increased “stickiness” and brand loyalty for the insurer’s medical products and also the potential for cross-selling ancillary products. Large broker groups will also be looking for ways to leverage private exchange offerings to serve their clients, although creating any Large group private exchange private exchange will hinge primarily on the ability to attract insurers to the arrangement. Roadside stand group solutions will likely be sponsors will need to navigate available to brokers of all sizes, but farmers’ market group plan anti-trust concerns while approaches will demand serious volume to warrant the effort of insurers to engage. Private multi-carrier large group arrangements developing multi-state and will be challenging to create and administer, in large part due to the multi-carrier risk adjustment need to risk adjust across many plans sold in many states. Federal risk adjustment models will apply to individual and small group markets, for fully insured large group but not necessarily to large group markets. Large group private products. exchange sponsors will need to navigate anti-trust concerns while developing multi-state and multi-carrier risk adjustment for fully insured large group products. In the near term, most large employers will probably continue to offer plans consistent with pre-ACA strategy; those that currently offer multiple networks or multiple carriers will continue to do so, and most will not be private exchanges (see Figure 1).

Figure 1. 2014 Large Market (100+) Scenario A Mid- to High-Wage Markets

Large Employers

Most likely: Traditional Self-Funded or Fully Insured Plan

Maintain Group Plan Less likely: Private HIX with Group Products

The State’s Big Decision Perhaps the most important exchange-related policy decision yet to be made in most states is the choice about whether to combine the risk pools for individual product and small group product. This determination will probably have greater effect on the markets than the state decision to build a state-sponsored exchange or defer to the federal solution. It will have significant impact in any given state on the viability of certain types of exchanges, and on the ongoing appeal of group insurance for smaller firms. If a state requires insurers to combine individual and small group risk pools with common

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adjusted community rates for both, many small groups which are not subject to the federal employer mandate will flee group coverage in favor of individual products since group pricing advantages will be eliminated. On the other hand, if a state keeps these pools separate, the pricing differential could favor small group significantly. New York is a good example in today’s market of a guaranteed issue, community rated individual market where the two pools are separate. In New York, small group rates are often half or less of individual policy rates for comparable plan designs from the same insurer.13 Rate differentials may not be on this scale under 2014 rating regulation, but even a 10-20% difference may be enough to encourage many small employers to maintain group plans (see Figure 2). Small group markets may remain robust in some states and less so in others. Health risk correlates inversely with personal income.14 Since the individual market will probably become heavily weighted with low income individuals due to the financial help available exclusively in the AHBE, it seems rational to expect that individual products may be more expensive than small group products assuming the risk pools are segregated. Further, insurers have long recognized that working populations are generally healthier than non-working populations, which is a key reason that worksite voluntary product insurers offer preferential pricing on individual products sold at the worksite. Small business groups will likely lobby aggressively for the separation of the small group risk pool from the individual risk pool to keep rates lower for small employers.

Figure 2. 2014 Small Market (1-100) Scenario A Small Group Segregated from Individual: Small group rates lower than individual rates for like products Farmers’ Market SHOP or Private HIX

Roadside Stand Small Employers

Maintain Group Plan Single Plan Offering SHOP or Traditional

Self-Funded Arrangement or PEO

Tax Policy as a Driver of Market Transition The ACA excludes individual AHBE plan premiums from tax advantage under section 125 cafeteria plans. This opens the door for traditional individual markets, and possibly newly developed private exchanges, to compete with federally approved AHBEs in the individual market and win business with middle and high income consumers primarily based on tax policy. Employers and employees will have a mutual interest in arranging pre-tax withholding for individually owned medical insurance under a cafeteria plan. Many middle income consumers may technically qualify for premium tax credits in the AHBE, but will learn on closer examination that they are better off financially to buy a non-subsidized product outside the AHBE and retain pre-tax status on the full premium. These consumers will certainly look for an alternative to the AHBE when shopping for individually owned products.

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In 2014, small employers in states where individual rates are similar to small group rates will likely contemplate whether to disband group health insurance based on the universal availability of individually owned policies (see Figure 3). If group insurance is not less expensive, small employers may question why they should continue sponsoring group insurance. For employers on the fence about group vs. individual product as a solution for their employee's health insurance needs, two ACA provisions will likely break the tie in the mind of the smaller employer: 1) small group product will restrict plan designs to relatively low deductibles for everyone in the group, and 2) low cost “catastrophic” plans available to individuals under age 30 will only be available in the individual market. One non-group approach involves canceling group insurance, offering salary increases in a discriminatory fashion if desired, and offering pre-tax withholding to all employees in a non-discriminatory section 125 plan, to provide tax cover for individually owned insurance as permitted under current regulation.15 For the convenience of the employer, individually owned policies might be included on a single consolidated bill to the employer. True policy portability from job to job would be the icing on the cake. This approach will have most appeal with employers (size 1-50) that are exempt from the employer coverage mandate.

Figure 3. 2014 Small Market (1-50) Scenario B Small Group Merged with Individual: Individual rates same as small group rates for like products Federally Qualified AHBE Disband Group Plan Private HIX with Individual Products

Small Employers 1-50

Consider Self-Funding

Self-Funded Arrangement or PEO

The employer mandate (“shared responsibility for employers”) may impose penalties (“assessable payments”) if the employer 1) fails to offer affordable coverage where the employee pays no more than 9.5% of household income for single-only coverage or 2) fails to offer a coverage level of at least 60% of the actuarial value of the covered benefits.16 If the employer fails either criterion, penalties may be incurred (see more detail in the section entitled “To Be or Not to Be: Group Insurance”). Related to the first criterion, employers cannot be expected to know the employee’s household income, so federal agencies have approved a safe-harbor that suggests the employer may use the employee’s W-2 wages to determine the affordability of the employer’s plan.17 Related to the second criterion, self-funded plans and fully insured large groups are not required to provide “essential health benefits” (EHB) but must provide “minimum essential coverage” (MEC) to avoid the employer penalties. EHB is a set of covered benefits, or a measure of what must be covered in individual and small group products, and EHB criteria may vary state to state. Large employers or self-funded plans may cover whatever they like within the boundaries of various state or federal coverage mandates, but must provide at least 60% actuarial value when considering the benefits they choose to cover, assuming the employer wishes to steer clear of employer mandate penalties. Employers are subject to the mandate if they have 51 or more full-time equivalents (where part-time workers are counted in the calculation), but the penalties only apply to fulltime workers, not to full-time equivalents.18

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A second alternative to traditional group insurance may be the use of the health reimbursement arrangement (HRA) on the front end of individually owned policies. Whether individual products purchased through these ERISA arrangements will be subject to group insurance regulation under HIPAA and the ACA remains to be seen. Legal precedent would suggest this is likely,19 although common large group market practices related to retiree plans are headed in the opposite direction. If group insurance regulations do not apply to individual products purchased with HRA funds, the “golden handcuffs” advantage sought by many employers can be maintained to some degree while accessing individual products by using the HRA funding mechanism. To date, this approach has not been permissible in most states due to HIPAA discrimination issues. In most states today, employees may get varying rate offers for commercial individual coverage, or no offer at all, based on health conditions. Guaranteed issue and adjusted community rating for all individual products beginning in 2014 will remove this obstacle in every state. The string attached to this approach will be the 105(h) discrimination regulations; employers using these plans will likely be required to benefit most employees in comparable fashion.20 It is unlikely that pre-tax HRA funding will be permitted for policies purchased in the AHBE, considering that the budgetary intent of the ACA appears to lean toward post-tax funding for individual premiums in the AHBE.21 Small employers weighing individual product solutions may consider the HRA route for control, or the section 125 route for simplicity, or a combination of both. In either case, it seems clear that the continued appeal of small group products will depend heavily on pricing differentials between community rated individual plans and community rated small group plans.

Small Group Experimentation in Self-Funding In addition to the non-group alternatives described above for small The continued appeal of employers, some healthier-than-average small groups may small group products will experiment with self-funding to get around the pricing restrictions of the fully insured community rate. Self-funding will also appeal depend heavily on pricing based on the exemption of self-funded plans and large group differentials between plans from the requirement to offer “essential health benefits”22 and certain actuarial levels of coverage (“metal” groupings), community rated individual which will allow self-funded plans to offer less expensive benefit plans and community rated designs. Further, self-funded plans are exempt from participation in risk adjustment which is mandatory for fully insured individual small group plans. and small group plans.23 Industry experts and federal officials are speculating about how much traction self-funded arrangements will get among small employers. In theory, if a small group purchases relatively low limits for aggregate and specific stoploss coverage, the group may run little catastrophic risk since the group would have the option to cancel the self-funded arrangement and flee to the guaranteed issue fully insured market if the risk becomes too great. Only employers with strong cash flow, healthy people, and an appetite for risk will likely consider this option. Another possibility for beating the small group community rate may be engagement with a professional employer organization (PEO). The PEO co-employment arrangement can allow small employers to join a larger risk pool. Technically, the employees of a smaller firm become part of a larger employer, which offers the possibility of lower rates if the risk pool of the large employer is more favorable than a community rated small group risk pool. PEO health plans may be fully insured or self-funded. Under current practice, some PEOs medically underwrite the prospective client prior to accepting the employer as a client, which can allow the PEO to reject groups with poor risk, which in turn keeps the risk pool cleaner and lower in cost. ACA rules prohibit group health plans (including self-funded plans) from engaging in medical underwriting beginning in 2014, although PEOs may argue that medically screening a prospective client prior to accepting the client relationship does not constitute medical underwriting on the part of the health plan. If “de facto” medical underwriting continues to be allowed in the PEO market after 2014, some healthy small employer groups may move toward PEOs to obtain better health plan rates.

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Defined Contribution: A New Approach to an Old Idea Employers began experimenting with defined contribution benefit plans in the late 1970’s by offering flex credits under an employer-sponsored cafeteria plan. Medical plan offerings of employers have been based on group insurance for many years because individual products have not been guaranteed issue in most states. Group plans typically offered coverage from one or two insurers or from one or two networks under self-funded arrangements. New defined contribution possibilities are arising for employers with the creation of farmers’ market exchanges, and with the availability of guaranteed issue individual products. Exchanges hold interesting possibilities for the employers that seek to divest some of the financial responsibility for medical inflationary pressure. Employer defined contributions may be funded through HRA plans whether insurance is provided through a group plan or through individual products that are guaranteed issue and community rated. In either case, employee contributions may be made by pre-tax payroll withholding under a cafeteria plan, which should be carefully monitored for non-discrimination. The employer that offers to fund individual products with the HRA will need to consider how employer mandate penalties might apply. It is unclear whether the HRA will satisfy the employer mandate requirement for the offer of group coverage in this case, and it may be complicated to demonstrate that the HRA has funded the required 60% actuarial value of coverage depending on what individual plans are available to the employee.

Large group health plans will probably remain mostly unchanged in 2014, except perhaps in low wage markets. As noted previously, health risk varies inversely with personal income, and generally, better educated people earn more. Defined contribution health plans which are presented farmers’ market-style may be most attractive to employer groups with better educated workforces since these solutions require a deeper consumer engagement than “one-size-fits-all” solutions. While insurers may initially resist the notion of farmers’ market group exchanges based on the desire to avoid sliced business, insurers may find that farmers’ market-style small group exchanges deliver better than average risk which may increase insurer interest in participation.

To Be or Not to Be: Group Insurance Large group health plans will probably remain mostly unchanged in 2014, except perhaps in low wage markets. The combination of employer mandate penalties and labor market pressures will likely encourage most large groups to continue offering employer-sponsored plans if they employ a large proportion of middle and high income earners. Depending on the growth in popularity of the “defined contribution” model for health care, the number and diversity of plan offerings for large employers may increase, and some may try to leverage the growing popularity of exchanges by promoting their singleemployer, multi-carrier offerings (in the case of fully insured plans) or multi-network offerings (in the case of self-insured plans) as a “private exchange.” Taft-Hartley plans (collectively bargained) and other multiple employer welfare arrangements (MEWA) can offer coverage to employees of many employers through a single group health plan, and some of these plans may consider either the farmers' market or roadside stand private exchange approach. Most large employers that consider a group private exchange will not pursue the MEWA model, but will seek employer-specific experience rated pricing as applied to each plan offering in the private exchange. Employers that employ mainly low wage workers will probably consider one of three alternatives when the employer mandate arrives in 2014 (see Figure 4). The first option will involve maintaining MEC-compliant group medical insurance, continuing to have low wage full-time job positions, and funding enough of the employee-only rate to avoid employer mandate penalties. Discrimination rules under section 105(h) are expected to prohibit the employer from leaving eligible low wage earners at a financial disadvantage to higher wage earners with respect to benefits and premium funding. Coupling budget constraints to non-discrimination boundaries, low wage employers may be expected to fund a minimal

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Emerging Health Insurance Exchange Models: The Intersection of Public and Private Exchanges

amount toward single coverage, and they may choose to base employee contribution on income (less than 9.5% of income) to be sure to avoid employer mandate penalties. According to a recent report by The Kaiser Family Foundation and Health Research & Education Trust,24 the nationwide average single-only rate for health insurance in 2011 was about $452 per month for all plan types, and about $400 per month for high deductible health plans (the lowest cost option in the study). Based on 2011 premiums, if a worker earns $8.50/hour and works 40 hours per week, the employer will need to be sure that the employee contribution for single coverage is less than about $140 per month. This would leave the average employer with responsibility to fund about $260 per month per eligible employee even when using a low cost high deductible health plan. By comparison, the employer mandate penalty will be $250 per month for each full-time employee that obtains a premium tax credit or cost-sharing subsidy in the AHBE, which the employer can avoid by engineering the single-only rate to be less than 9.5% of W-2 wages for any given eligible employee. Low wage employers will need to consider the labor demand of higher wage workers related to health care, which might be satisfied by “grossing up” salaries of certain employees and offering all employees the opportunity to withhold employee contributions (for single or family premium) pre-tax under a section 125 cafeteria plan. Under this option, the employer may have some difficulty recruiting low wage labor if the worker has dependents since the availability of “affordable” employee-only coverage through the employer will disqualify the entire family from receiving relatively low cost family coverage through a federally subsidized AHBE plan.25

Figure 4. 2014 Large Market (100+) Scenario B Low-Wage Markets Insure Low Wage FT Workers

Traditional Self-Funded or Fully Insured Plan

Fund to the Single Rate

Maintain Group Plan Eliminate Low Wage Eligibility

Private HIX with Group Products

FT to PT for Low Wage Jobs

Federally Qualified AHBE Disband Group Plan Private HIX with Individual Products

The second approach would involve reducing low wage jobs from full-time to part-time status, and maintaining a MECcompliant group medical plan only for the higher wage earners than are offered full-time employment. This will relieve the employer of the financial burden of providing group medical coverage to low wage workers, and also leave the employer out of harm’s way regarding the employer mandate penalties. On the surface, this looks like an attractive option with respect to health care cost containment. On the other hand, employers that follow this track will find themselves dealing with significantly higher human resource cost as they deal with recruiting, hiring and training many more employees.

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Emerging Health Insurance Exchange Models: The Intersection of Public and Private Exchanges

Further, the employer will need to carefully consider the overall effect of employing mainly part-time people as they look at turnover rates, productivity and quality. What might appear to be the low cost health care option may be detrimental with respect to the overall performance of the company. Employers pursuing this solution may still be subject to the employer mandate penalty of $250 per month for each full-time employee that obtains a premium tax credit or cost-sharing subsidy in the AHBE, which may be applicable to some middle income earners that retain full-time employment. The third option for low wage employers will involve eliminating the group medical plan altogether, and accepting the employer mandate penalty as a cost of doing business. Many low income wage earners will find that family insurance coverage is significantly more affordable in the AHBE than in the group plan of the low wage employer. For example, a family of four with two full-time low wage workers (husband and wife) may be able to access family health insurance in the AHBE for about $109 per month.26 The best deal on family health insurance for many low income wage earners will be in the subsidized AHBE, but the worker will be disqualified from receiving the premium tax credits and cost-sharing subsidies if affordable employee-only coverage can be obtained through an employer’s plan. Low income wage earners with Many low income wage families may therefore intentionally seek employment with firms that do not offer group medical insurance. The employer earners will find that family mandate penalty will be equivalent to $166.67 per full-time insurance coverage is employee per month (counting all full-time employees less 30 people) assuming that at least one full-time employee obtains significantly more affordable a premium tax credit or cost-sharing subsidy in the AHBE, which is in the AHBE than in the very likely with a low wage employer. Based on national average premiums referenced previously, the employer penalty will be group plan of the low wage lower than the cost of providing employee-only insurance, let employer. alone the expense of providing family insurance based on a $109 monthly employee contribution. As under the first option described here, the employer may consider “grossing up” wages for higher earners and offering pre-tax withholding for individual medical insurance to satisfy labor demand. Higher earners should be satisfied with this approach as long as individually owned policies are relatively affordable in the state in which the employee resides. Since large group plans will continue to be experience rated both inside and outside exchanges, the appeal to drop group coverage in favor of individual product offerings will depend on how the group’s rates compare to the weighted average of the individual community rates in the states where employees reside. Private individual product exchanges could co-exist alongside the AHBE as a complementary solution where the AHBE serves the low wage workers and the private exchange serves the mid to high wage earners.

Consumer Driven Tools and Ancillary Offerings in Exchanges Exchanges have an opportunity to help consumers choose wisely. Premium cost matters tremendously to consumers, although premium alone does not reflect overall value, nor does it accurately project the true cost of ownership. Advanced shopping tools can help consumers project out of pocket expenses in addition to premium cost based on how personal utilization may drive cost sharing such as deductibles, copays, coinsurance and so forth. These tools can help consumers make personalized buying decisions. Exchanges will also be well positioned to present both provider and insurer cost and quality information to consumers in a simplified and meaningful way as such data becomes more available, which will help consumers make better informed decisions regarding which plans, providers or networks provide the best value. Furthermore, an exchange could incorporate the infrastructure to administer wellness plans on behalf of employers or insurers.

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Emerging Health Insurance Exchange Models: The Intersection of Public and Private Exchanges

Federally approved exchanges will offer medical insurance and dental coverage for some consumers. Private exchanges will be at liberty to offer a variety of products including dental, vision, life, disability, long-term care, worksite supplements, and other traditional employee benefit programs. Private exchanges will also be well positioned to offer employer-facing technology platforms that administer all varieties of employee benefits coupled with payroll integration.

Brave New World for Brokers The terms and conditions of product distribution will be controlled by the entity that sponsors the public or private exchange. Insurers are already beginning to reduce sales commissions based on medical loss ratio regulations, which signals the intent to begin a more “direct to consumer” distribution strategy. Many insurer-driven roadside stand solutions will likely go this direction, especially in markets dominated by one or two insurers. Producers (brokers or consultants) that sponsor private exchanges will be positioned to negotiate reasonable recurring revenue with insurers and/or employer clients. In an exchange environment, producer compensation could be structured independent of insurers to keep compensation outside medical loss ratio calculations. In the Utah Health Exchange, insurer premiums are submitted net of commissions, and producer compensation is added on by the Exchange as a transparent commission disclosed on every employer invoice; producers are then paid by the Exchange. Utah Health Exchange producer compensation is standardized regardless of the product chosen by the consumer, so the producer has the incentive to act as a “buyer’s agent” rather than a “seller’s agent” which aligns nicely with the advancing trend toward deeper consumer engagement. Producers represent a powerful potential exchange sponsor based on their role as trusted advisors of employers, and employers may be a key to insurance distribution in the future even if individual products become a popular solution for employers.

Looking to the Future Public and private exchanges will fundamentally change the landscape of individual and small employer product distribution assuming the survival of the ACA provisions related to public exchanges, premium tax credits, cost-sharing subsidies, and individual market guaranteed issue. Employers will increasingly look to some form of exchange to implement the defined contribution approach to health care and benefits. Some markets currently served by group insurance will give way to individual policy ownership, including some large employers that operate in a low wage environment and smaller employers in states where individual and small group products are priced similarly. Insurers may engage in a variety of farmers’ market exchanges as well as proprietary or broker-driven roadside stand solutions to offer individual and group products. Some insurers will cast the net more broadly than others based on the availability of technical and functional resources needed to interface with exchanges. Prospective private exchange sponsors have a valuable opportunity to deliver individual and/or group insurance products along with ancillary insurance, and when targeting employer group relationships, possibly human resource tools including payroll integration. Nimble and savvy insurers, brokers, benefit administrators, financial services providers and large retailers will quickly move to find or develop exchange infrastructure to serve their constituencies and capture the new opportunity to distribute insurance through exchanges.

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Emerging Health Insurance Exchange Models: The Intersection of Public and Private Exchanges

1

Author interview with Patty Conner, director of Utah’s Office of Consumer Health Services, January 12, 2012.

2

Section 1302(c)(2) of the Patient Protection and Affordable Care Act (ACA).

3

Section 1302(e)(3) of the Patient Protection and Affordable Care Act (ACA).

4

Section 1515(a) and Section 1311(d)(2)(B)(i) of the Patient Protection and Affordable Care Act (ACA).

5

http://www.businessweek.com/small-business/why-few-employers-use-healthcare-tax-credits-11152011.html

6

Section 45R(b) of subpart D of part IV of subchapter A of chapter 1 of the Internal Revenue Code of 1986, as amended by section 1421(a) of the Patient Protection and Affordable Care Act (ACA).

7

Section 1555 of the Patient Protection and Affordable Care Act (ACA).

8

Federal Register/ Vol. 76, No. 136/ Friday, July 15, 2011/ Proposed Rules. See Part 155, Subpart H-Exchange Functions: Small Business Health Options Program (SHOP), §155.703 paragraphs (b)(2) and (b)(3).

9

Section 2701(a)(1) of the Public Health Service Act as amended by Section 1201 of the Patient Protection and Affordable Care Act (ACA).

10

Section 2718(b)(1)(A) of the Patient Protection and Affordable Care Act (ACA) as amended by section 10101(f) of the Health Care and Education Reconciliation Act of 2010 (HCERA).

11

Section 1301(a)(1)(C)(iii) of the Patient Protection and Affordable Care Act (ACA).

12

Section 1343(c) of the Patient Protection and Affordable Care Act (ACA).

13

Author interview with prominent New York health insurance consulting firm, January 6, 2012.

14

http://www.pceo.org/pubs/JHCPU.pdf

15

http://edocket.access.gpo.gov/2007/pdf/E7-14827.pdf . See § 1.125–1(m).

16

Section 1513 of the Patient Protection and Affordable Care Act (ACA). See also Section 36B(c)(2)(C)(ii) of Subpart C of part IV of subchapter A of chapter 1 of the Internal Revenue Code of 1986, as created under section 1401 of the Patient Protection and Affordable Care Act (ACA).

17

IRS Notice 2011-73.

18

Internal Revenue Code of 1986 §4980H(c)(2)(E) and §4980H(c)(4)(A).

19

American Medical Security v. Bartlett, 111 F.3d 358 (4th Cir. 1997). Donovan v. Dillingham, 688 F.2d 1367 (11th Cir. 1982). 29 U.S.C. 1002(1); Donovan v. Dillingham, 688 F.2d 1367 (11th Cir. 1982).

20

http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00000105----000-.html . See Section 105(h).

21

Section 1515(a) and Section 1311(d)(2)(B)(i) of the Patient Protection and Affordable Care Act (ACA).

22

Section 2707(a) of the Public Health Service Act as amended by Section 1201 of the Patient Protection and Affordable Care Act (ACA).

23

Section 1343(a) of the Patient Protection and Affordable Care Act (ACA).

24

The Kaiser Family Foundation/Health Research & Educational Trust 2011 Annual Employer Health Benefits Survey.

25

Husband and wife both working 40 hours per week and each earning $8.00 per hour (slightly above the federal minimum wage of $7.25 per hour) collectively earn $33,280 assuming 52 weeks of labor per year. If the couple has 2 children, then based on family size and household income, the family is about 149% of the federal poverty level (FPL) based on 2011 FPL standards as applied in the 48 contiguous states and the District of Columbia. As a result, the family’s AHBE premium cap would be set at about 3.94% of household income, which equates to about $1,311 per year, or about $109 per month.

26

http://www.gpo.gov/fdsys/pkg/FR-2011-08-17/pdf/2011-20728.pdf. See page 5 of 19.

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About bswift bswift (www.bswift.com) offers software and services that streamline benefits, HR and payroll administration, and currently serves over one million users. bswift has built over 2,000 interfaces for electronic data transmissions to various entities including medical insurers, ancillary insurers, payroll vendors, and third party administrators of COBRA, FSA, HRA, and HSA plans. bswift is the exclusive eligibility and enrollment vendor for the Utah Health Exchange, the nation’s second public health insurance exchange, and is seeking opportunities to administer public and private exchanges that serve either the individual or group markets. The author may be contacted at dgarlitz@bswift.com.

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Emerging Health Insurance Exchange Models: The Intersection of Public and Private Exchanges