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Individual Coverage for Employees: Health Care Reform (ACA) May Create Opportunities for Small Businesses

(UPDATE: Dec., 2014 – This article was written in January 2013.  Since then the IRS and DOL have come out with rulings that explicitly state that an employer can NOT reimburse employees for individual health insurance plans.  Also, we now know that  in California individual plans have significantly smaller provider networks than small group plans and they are not identical products.  The article below explored a hypothetical situation which we now know is not viable, legal or advisable. See this blog post for more info.)

The Affordable Care Act (ACA) will change the rules for purchasing individual and small group health insurance. While many of the rules have not been finalized, a savvy business owner (or one with a knowledgeable agent/broker – like BenefitsCafe.com) will have new opportunities to lower the cost of care for employees.

Specifically, the ACA may allow business owners who purchase health insurance for their employees to engage in a type of “arbitrage.”  Wikipedia defines arbitrage as “the practice of taking advantage of a price difference between two or more markets.”

Health insurance plans with identical benefits, offered without regard to health status (i.e., no medical underwriting – the insurance companies must accept everyone) – will be available in both the small group market and the individual/family market. (NOTE: This assumes that the provider networks of doctors and hospitals is identical in both the individual and small group market – we know now (December 2014) that individual plans have significantly smaller networks.  Consequently, these are NOT identical products in the individual and small group markets.)

Accordingly, in 2014, when the new market rules take effect, a business owner may be able to choose between the small group and individual market when purchasing coverage for employees.

The insurance companies will price the policies in each market based on separate populations with separate levels of usage.  Stated another way – small group rates will be based on the number of healthy and sick people in the “pool” of employer groups.  Individual and family rates will be based on the claims experience of individuals and families in a separate pool.

By law, the plans offered in both pools must include “essential benefits” (i.e., coverage for in and out of hospital care, prescription medicine, maternity coverage, etc.)  Same product in two separate markets offered at different prices.  A small business owner’s arbitrage opportunity would be to purchase health insurance for employees in the market with the lowest price.

So, how will an employer (or more likely his/her agent/broker) take advantage of this opportunity?

Step 1: Quote the employees and dependents of a small group in the small group market.

Step 2: Quote the employees and dependents in the individual market and organize the data to allow comparison with the small group quote.

Step 3: Determine if there is a significant price savings from converting from small group to individual plans.

Step 4: If the answer to step 3 is “Yes” then estimate the transactional costs of converting a small group to individual plans.

The “transaction costs” of enrolling the employees of a small business (2-50 employees) into individual plans would be the method of consolidating all of the individual policies into one bill which the employer can pay jointly with employees in a tax-favored way. In some cases this might involve the services of a Third Party Administrator (TPA) (see below.)

Insurance companies have not offered guidance on whether they would allow a group to offer employees individual plans. Business owners will need to ensure that the individual policy payment is set up so that it qualifies as a deductible business expense with the IRS.  We at BenefitsCafe.com do not give legal or tax advice and business owners should consult an accountant and/or attorney for tax advice.

Employers must make sure that the method they adopt: 1) is acceptable to the insurance company that offers coverage; and 2) complies with the IRS guidelines for the deductibility of health insurance premium.

I do not know if the IRS allows employers to deduct the premium of individual health insurance plans as a business expense. This is allowed on group health plan.  IRS 15-S “Employer’s Tax Guide to Fringe Benefits” provides some guidance for employers.

List Bill: One method to administer individual policies for a small business would be for an insurance company to “list bill” the employer for individual plans. In this arrangement an insurance company sends one bill to the employer.  That bill lists all of the individual policies held by the company’s employees. Employers would pay their portion of the premium and deduct the employee’s contribution from employee’s paychecks. The employer would remit one company check to the insurance company. Theoretically, employees could use pre-tax dollars under Section 125 to pay their individual premium.  This is a hypothetical situation and not intended as tax advice or guidance. Ask your accountant if this sort of arrangement would enable both the employer and employee to deduct the health insurance premium as a business expense.

Subsidies: Low wage employees who purchase individual medical insurance in “Covered California” (California’s Health Benefit Exchange) may qualify for tax subsidies that will lower the cost of their health insurance plan.  I do not know if the IRS or Covered California will allow an employer to pay a portion of an individual’s health insurance premium if that same person also obtains a tax subsidy for his/her coverage.  If employers are able to pay a portion of the health insurance premium along with a government tax subsidy; it would encourage many small businesses to sponsor medical insurance plans for their employees.  Policy makers should fully explore this option.

Health Reimbursement Arrangement (HRA) – Section 105 Plan: Another method for employers to use individual plans for group coverage may be through a Section 105, Health Reimbursement Arrangement.  Here a Third Party Administrator (TPA) receives payments from an employer and reimburses employees for qualified medical expenses.  Medical insurance premium is a qualified medical expense. This sort of arrangement has added costs (for the TPA) but it may be the only way an employer can truly offer benefits to employees using individual plans and receive full tax benefits.  Again, we at BenefitsCafe.com are neither accountants nor attorneys and do not offer legal or tax advice.

The ACA will change most of the rules that regulate small group and individual health insurance in California. With change comes opportunity. Arbitrage between the small group and individual market may be an opportunity for small business owners.