Common Sense vs. the CBO on ObamaCare

Both the House and Senate versions of the healthcare reform bill would require employers above a certain size to provide health insurance for their workers or face some sort of penalty. The House bill that passed last month would require employers to pay an 8% additional payroll tax for not insuring their workers. The Senate bill now under consideration is much less punitive, requiring employers who do not provide insurance to pay a $750 annual fee per full-time worker, but only if one or more of their employees receive a government subsidy in the insurance exchange.

Quite a difference between the two bills. By way of example, take an employee earning $50,000 per year. Under the House bill, an employer who did not provide insurance would be required to pay an additional tax of $4,000 to the federal government. Compared to only $750 under the Senate bill – a difference of more than 500%.

Now consider whether it would make more sense financially for the employer to provide insurance or pay the penalty. In our example above, under the House bill it would probably be close to a break-even if the employer is providing coverage only for the employee. According to the most recent data from the Bureau of Labor Statistics (BLS), the average monthly insurance premium for private industry employers across all worker categories was $317.63. Or just over $3800 annualized (compared to the $4,000 penalty). However, it would be quite a bit more expensive if the employer was providing family coverage (BLS data: $737.68/mo – $8850/yr).

Obviously under the Senate bill it would be far less expensive for the employer to just pay the $750 penalty rather than provide the insurance.

This is just one example, but importantly, note that under the House bill, the lower the average wage base of the employer, the more cost effective it would be for the employer to pay the 8% penalty rather than offer insurance coverage. In fact, an average wage base of $50K is probably close to the tipping point. An employer with average wages much lower than this would likely find it less expensive to not provide insurance for their employees. And correspondingly, any employer with an average wage higher than $50K would likely find it more cost effective to provide insurance.

Of course under the Senate bill, practically speaking there is no tipping point. Given the cost of health insurance, it would make far more financial sense for every employer to ante up the $750 per worker rather than provide health insurance.

So with the Senate bill especially, wouldn’t it be reasonable to assume that a large number of employers would elect to not provide insurance coverage once the bill goes into effect?

The Congressional Budget Office (CBO) doesn’t seem to think so. Based on their analysis of the Senate bill, by 2019 only 5 million fewer individuals will receive insurance coverage through an employer compared to current law. (Note that this total also includes family members who would otherwise receive coverage through an employer policy). With the CBO’s estimated total of 162 million people receiving employer-based coverage in 2019, that’s a reduction of only about 3%.

I’m going to give some examples to demonstrate why this defies common sense, but here’s why this is so critically important. The more people who do not receive coverage through an employer, the more who will wind up in the federal insurance exchange. And the more people in the insurance exchange, the more subsidies the government will be required to pay under the terms of the bill. Under the Senate bill, individuals and/or families earning up to 400% of the poverty level will receive some level of federal subsidy. With the CBO’s estimate of an average annual subsidy in excess of $5K per subsidized enrollee, the incremental cost could add up pretty quickly if their estimates turn out to be inaccurate.

Let’s assume under the Senate bill that 5% of individuals lose their employment based coverage rather than the 3% estimated by the CBO. (Still a very conservative estimate in my opinion). This would result in an additional 3 million individuals in the exchange, and an incremental annual subsidy cost of up to $15 billion. Even under the accounting method that the Democrats are using (accelerating revenues, and deferring costs), this would increase the initial 10 year cost of the bill by another $50-75 billion. Not an insignificant amount. And this total would be dramatically higher if a greater number of employers elect to dump their coverage. (A 10% drop in employer coverage would result in an additional cost in excess of $50 billion per year).

So why is the CBO estimate so low? I’m not exactly sure – hopefully a Senate Republican will press the CBO for a more detailed explanation of the data and assumptions that went into this calculation. My best guess based on the CBO analysis of an earlier House committee bill is that they are assuming that the competitive dynamic within the labor market will largely dissuade employers from dropping their insurance coverage. Because current and prospective employees will continue to demand this benefit as a condition of employment, and because any employer who does not offer insurance would have their talent raided by an employer who does.

While I think this will likely be an important factor in the higher end of the labor market, I don’t think this will be a compelling factor for many industries and professions farther down the wage scale. The reason is really quite simple: federal subsidies will be available for individuals to obtain insurance in the exchange.

Let’s take the example of a single large employer – like Wal-Mart – which currently offers health insurance for the majority of its employees (including many part-time employees). The average hourly wage of a full-time store worker at Walmart is just over $11/hr (source). Given that this wage level is very close to the federal poverty level, under the Senate bill most employees of Wal-Mart would be eligible for either Medicaid coverage at zero cost or a federal subsidy in the insurance exchange which would limit their annual cost to no more than 2-3% of their income.

Since most Wal-Mart employees who participate in the company-provided insurance plan contribute more than 3% of their income now (source: Wal-Mart Watch), they would actually be better off under the new government plan. And at a cost of only $750 per full-time worker, so would Wal-Mart. In the business world, this is what’s called a “win-win”.

Wal-Mart has over 2 million employees.

Granted they are probably the largest company which falls into this category, but how many other large retailers will be looking at this same calculus? Costco, Home Depot, McDonald’s, Starbucks…just to name a few. And how many other industries are there which consists primarily of people making less than $30K per year? More than a few, I’m sure. Considering the substantial savings for these employers, and considering that the majority of their workers will pay no more – and possibly less – in the insurance exchange than they do for their current coverage, the Senate bill is virtually rigged to lead low-wage employers to drop their coverage.

And if the prospect of spending only $750 per employee for health insurance costs is not enticing enough, there is one more big incentive for large employers with predominantly low-wage employees to ditch their coverage and send their workers to the federal exchange. Most very large employers (including Wal-Mart) self-insure, meaning they typically carry a large reserve on their books to cover the expected costs of the healthcare services its employees and their eligible family members will use in the future. (Wal-Mart, for example, reported an accrued liability of $3.1B for their self-insurance reserve as of 1/31/2009.)

Guess what happens to these reserves once the company passes off responsibility for their employees’ coverage to the feds? No more long-term liability, no more need for a reserve. Cha-ching, straight to the profit line.

Considering the clear incentives, along with a little common sense, the CBO’s estimate seems highly questionable at best. In fact, as implausible as it sounds, the CBO is actually forecasting that employer-based coverage will continue to grow over this timeframe. Based on the growth in the overall workforce. The 5 million figure really just represents a reduction in the growth rate of employer-based coverage, compared to what it would be under current law. (With the House bill, the CBO has gone even farther, estimating a net increase of 7 million people with employer-based coverage compared to current law.)

If nothing more than the accuracy of the number (and the credibility of the CBO) was at stake, it would be enough to just predict that they are wrong and see what happens down the road if the bill passes. However, given the importance of this estimate on the total cost of the bill, and the massive increase in federal spending which will result if the CBO is wrong, I think it’s deserving of a lot more scrutiny. Hopefully the Republican leadership will press the CBO for a more detailed analysis of this calculation.