Could next year be the beginning of the end of traditional employer-sponsored health insurance?
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The same type of transformation that turned traditional pension plans into employee-directed 401(k)s may be coming for employer-sponsored health plans—and sooner than most realize.

The consequences of this transformation would be widespread, with impacts throughout the health care system, from hospitals and doctors to drug and device makers to insurance companies, brokers and vendors. It could even impact the political debate about single-payer health care.

A new rule from the IRS and other federal agencies could set this afoot. Beginning in January 2020, any employer can give employees pretax compensation to buy individual market health insurance instead of providing a traditional employer-sponsored group health plan.

Thinkers from across the political spectrum have long decried the uniquely American phenomenon of tying health benefits to employment. In addition to creating an artificial linkage between employment and health coverage, generous employer-sponsored health benefits may play a role in driving health care inflation. But two factors have generally preserved the status quo, with about half of Americans in employment-based coverage.

First, until the Affordable Care Act was implemented, the individual market for health insurance was not functional in many places, leaving employers with few options if they wanted to ratchet back their health benefits. Individuals could have been denied coverage or charged higher rates based on health status, or had pre-existing condition exclusions imposed.

Second, both before and after the ACA, employers had a significant incentive to provide generous health benefits because employer spending on a health plan is not treated as taxable income for the employee, effectively increasing the value of this form of compensation to the employee. The ACA added to this incentive by affirmatively requiring large employers to share in the responsibility for providing health coverage to employees. On top of this, Obama-era rulings interpreting the ACA effectively precluded all employers (large and small) from contributing to the cost of individual coverage obtained by employees.

The ACA fixed the first problem—guaranteeing access to individual market coverage at a uniform price regardless of health status and without pre-existing condition exclusions—but in doing so exacerbated the second. The new federal rule now solves the second problem: Employers will be permitted to fund “health reimbursement arrangements” (HRAs) for employees to buy individual market health insurance. The employee does not pay income tax on amounts the employer contributes to the HRA.

The major remaining constraint on the 401(k)-ization of employer health benefits will be the pressures of the labor market. Will employees accept jobs that don’t guarantee them particular health benefits but instead offer defined contributions to an HRA that may or may not be sufficient to buy equivalent coverage on the individual market? Many employers would love not to have to bear the administrative burdens of running a traditional health plan, and all are looking for ways to keep health costs down. How many will be willing to test the labor market in this way?

The federal government estimates that within five years, about 11 million people will receive individual market coverage funded through an HRA, but those people will be spread across 800,000 employers, meaning only about a dozen employees will get health care this way from each participating employer. The IRS admits this estimate is highly uncertain, but there is little reason to think so few employers will make this shift, or that it will remain limited to very small employers. As with other disruptive innovations, it is entirely plausible that what begins in the low end of employers will take over the entire sector. Further, even among the 11 million the IRS predicts, the IRS estimates that most will be replacing conventional group health plans with HRAs—these are not employees, for the most part, whose employers are using an HRA to offer coverage for this first time.

The consequences could be dramatic. Today, reimbursement by employment-based health plans is the fuel that drives many sectors of the health economy, in many cases keeping afloat hospitals, physicians, dialysis providers, drug and device makers, and other providers that may receive lower reimbursement for patients on Medicare or Medicaid (and nothing for those who remain uninsured). And, at least today, the individual market coverage that an HRA would buy is quite different from employment-based coverage: Typically there are fewer providers in network, who may receive lower reimbursement rates. There may be no out-of-network benefits except in emergencies, and deductibles and other enrollee cost-sharing are often much higher.

If millions more people join the individual market through HRAs, these plan design features could change to look more like conventional employment-based coverage—or HRAs may further incentivize lower-premium plans, reinforcing the need for less comprehensive plans. Either way, each sector of the health care system will need to think about the implications: Hospitals and doctors will need to continue their focus on collecting payments from individual patients with high-deductible plans, and all providers will need to understand a world of potentially lower reimbursement and higher enrollee cost-sharing. Brokers and tech vendors will need to help employees navigate increasingly complex coverage decisions. Insurers may need to adjust to the higher administrative costs implicit in individual market coverage.

The shift could also impact political realities: A significant hurdle to state and federal “single payer” health care reform is the general satisfaction today of the millions of people in employment-based coverage, representing about 60 percent of nonelderly adults. If these people are shifted to higher-deductible plans with narrower provider networks, and are forced to comparison-shop for a plan each year, the fortunes of single payer could improve, as the alternative begins to seem less attractive.

In short, the health care system must wrestle with whether HRAs will make traditional group health plans as rare as traditional “defined-benefit” pensions, and, if so, how quickly.

Michael Kolber is a partner at Manatt Health.