Why Employers Will Continue to Provide Health Insurance: The Impact of the Affordable Care Act

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The Congressional Budget Office, the Rand Corporation, and the Urban Institute have estimated that the Patient Protection and Affordable Care Act (ACA) will leave employer-sponsored coverage largely intact; in contrast, some economists and benefit consultants argue that the ACA encourages employers to drop coverage, thereby making both their workers and their firms better off (a "win-win" situation). This analysis shows that no such "win-win" situation exists and that employer-sponsored insurance will remain the primary source of coverage for most workers. Analysis of three issues--the terms of the A CA, worker characteristics, and the fundamental economics of competitive markets--supports this conclusion.

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It is no accident that the Patient Protection and Affordable Care Act (ACA) was designed and promoted as a way to build on, not replace, the employer-sponsored health insurance system that now covers most working-age Americans. Avoiding displacement of privately financed employer-based coverage was key to achieving politically feasible financing for the ACA's coverage subsidies for low-income households--which are available, through tax credits and Medicaid, only for insurance provided outside the workplace.

Although most analyses, including those done by the Congressional Budget Office (CBO), (1) the Rand Corporation (Eibner et al. 2010), and the Urban Institute (Blavin, Buettgens, and Roth 2012), have concluded that the law will leave employer-sponsored health insurance largely intact, questions about how the incentives of the law will actually play out remain very much alive. Some benefit consultants' reports of employers' greater-than-anticipated interest in dropping coverage (Singhai, Stueland, and Ungerman 2011; Mercer, LLC 2011; Towers Watson 2011) have fueled claims that the CBO and others seriously misjudged employers' incentives and significantly underestimated subsidy costs under the ACA. Some prominent economists see the law's incentives as likely to induce a wholesale shift away from employer-sponsored coverage (Holtz-Eakin and Smith 2010). Others foresee a more modest but still substantial shift as employers increase employees' premium contributions, thereby encouraging low- and modest-wage workers to take advantage of publicly subsidized coverage (Burkhauser, Lyons, and Simon 2011). In either case, these analysts raise the prospect of public subsidy costs that will be substantially higher than estimated.

The key to the ACA's actual impact on employer-sponsored insurance (ESI) will be whether the employers of most workers continue to see their employees as valuing employer-provided health insurance over the alternative created by the ACA. And, under the terms of the ACA and the pressure of a competitive marketplace, our analysis shows they overwhelmingly will.

The bottom line is that most workers will be in firms dominated by employees who will receive better benefits and, through the tax system, better subsidies via employer-provided coverage than through newly created insurance exchanges. The strength of employee preferences may be hard to read in the short term, and some employers may seek immediate financial gain in benefit reduction as markets adjust to new circumstances. Over time, however, coverage reductions inevitably will make worse off those workers that employers most want to keep, and if those workers seek employment elsewhere as a result, then the firm will be worse off as well. It is therefore unlikely that large numbers of employers currently providing insurance coverage will change their decisions to offer it.

Although projections of future behavior are inherently uncertain, the conclusion by the CBO and other analysts that the ACA will leave employer-sponsored coverage intact rests on simulations of the complex interaction of multiple factors in shaping employees'--and thereby employers'--coverage preferences over the long term. By clarifying these factors, analyzing the way that the ACA does or does not affect them, and examining how their influence on employers can be best understood, we explain why we believe that most Americans will continue to rely on employers for health insurance coverage even after the major ACA provisions are implemented in 2014.

Employers' Interest in Providing Health Insurance Coverage

Beginning in the 1940s and growing over the following decades, several factors converged to establish job-based benefits as Americans' primary route to health insurance protection. In brief, insurers learned they could lower administrative costs and avoid "adverse selection" (the purchase of insurance only by people anticipating they would get sick) by selling to large employers; labor unions took advantage of regulators' determination that health insurance and other fringe benefits were subject to collective bargaining; wage freezes during World War II gave employers a powerful incentive to offer health insurance to attract workers in a tight labor market; and tax policy administratively and then legislatively, culminating with a 1954 ruling by the Internal Revenue Service, exempted employer-paid premiums from employees' taxable income, essentially subsidizing its costs. These insurance market, labor market, and tax incentives worked together to make workplace-based health insurance better and cheaper than the insurance that employees could obtain on their own. Employers seeking to attract and retain workers therefore increasingly came to offer health insurance, and employer contributions to employees' health insurance became an integral part of most workers' compensation.

The dominance of employer-sponsored health insurance did not make it universal. Its availability reflected what employers in different circumstances with different demands for labor found necessary to attract an adequate workforce. Employers able to attract workers at low wages have always been less likely to offer coverage; low-wage workers lack sufficient clout in the labor market to command better wages, let alone better benefits. The level of employers' contributions and the benefits they offer have always reflected variations in health care costs. Small employers, which have had to pay the higher administrative costs per worker associated with providing insurance to small groups and other employers of low-wage workers are less likely to offer--or are likely to offer less generous--benefits. In 2010, only four in 10 firms with predominantly low-wage workers provided health insurance, compared with more than six in 10 among firms dominated by better-paid workers (see Table 1).

These variations reflect the …