Frequently asked questions about private exchanges

We received a number of thoughtful questions during our May 22 webcast on the value proposition of a private exchange, and I’d like to share our responses to some of them.

Q:  What is the difference between the defined contribution model and the traditional cafeteria plan?

A:  The original concept behind the cafeteria plan, which launched in the 1970s, was to use a combination of employer and employee contributions to fund the employee’s choice of benefits; and the current movement around defined contribution is similar. In fact, defined contribution today can be implemented using a cafeteria plan (i.e., using pre-tax dollars with Section 125 plans), a health reimbursement arrangement, or a combination of the two, to achieve maximum tax advantage.

At bswift, we are big believers in the importance of flexibility in the contribution strategy, and we support a combination of defined benefit plans (100% employer paid or contributory) and defined contribution plans. With the latter, we allow contributions to be earmarked by product line or product category, including the ability for the employer to control how employees can use leftover money from any category.

Q:  Will defined contribution mean that employees will buy individually owned insurance?

A:  Defined contribution for health care will typically involve group insurance rather than individually owned plans, mainly because the latter don’t allow for pre-tax employer or employee contributions. This was first clarified in the fall of 2013 with IRS Notice 2013-54, and is reinforced on the IRS’ Employer Health Care Arrangements page, published in May of this year. While post-tax employer contributions toward individual health plans are permissible if set up properly, the loss of tax efficiency and the specter of the excise taxes related to the employer mandate will probably keep large employers in the group insurance game as long as tax rules stay as they are today. 

Q: How can a multiple carrier, employee choice offering be price competitive? Won’t risk selection make that type of arrangement more expensive for group plans?

A:  Each fully insured plan (or carrier) must take into account the possibility of adverse risk selection, which occurs when a greater percentage of higher cost participants are on a particular plan compared to the other plans. To offset any significant imbalance in how risk is distributed among the plans, plans generally charge more for the extra risk—unless there is a mechanism in place to help make the plan whole for disproportionate losses.

In a nutshell, risk adjustment measures how healthy each participant is, skims money from the premiums of the healthiest people and makes those dollars available to the carrier(s) that insure the higher cost participants. The Affordable Care Act requires risk adjustment for the individual and small group markets (defined in most states today as employers with 50 or fewer employees), but larger employers do not participate in ACA risk adjustment. As a result, private marketplace arrangements that target larger employers will either incorporate risk adjustment into the multiple-carrier, employee-choice model, or focus on single carrier offerings.

For self-insured plans, the employer bears the risk of the entire group, so the concern shifts from losing revenue to an outside entity to setting appropriate rates for each plan in the offering. 

From our point of view, private exchanges or marketplaces can optimize their value and appeal by giving the consumer choice on two key dimensions: plan design and network (i.e., physician and hospital) access.  Consumers will derive value from fully insured or self-insured plans that can provide multiple plan designs and meaningful choice between lower cost narrow networks and more costly broad networks.  Employers don’t really want to force lower cost options on employees, but early evidence from private marketplaces indicates that a large proportion of consumers are willing to buy down—i.e., select smaller networks and/or higher deductibles—when given the choice along with some financial incentive. 

Q:  How can private exchanges provide assistance to employees that go to the public exchanges?

A:  To properly address this issue, we should distinguish between employees who are eligible for benefits and those who aren’t. Benefits-eligible employees generally won’t benefit from the public exchange tax credits unless employer-based coverage is not offered or is of low value (not minimum value) or unaffordable. So, in general, employers won’t be making the effort to send benefits-eligible people to the public exchanges in the first place. One possible exception may be with low-wage, benefits-eligible employees where the employer engages a service to help enroll employees on Medicaid. 

But for employees who are ineligible for benefits or for former employees (retirees or COBRA), the employer may be willing to assist with finding coverage. One way to do this would be to connect these employees with a resource (via phone and/or web) that can provide guidance about their options on the public exchange, including an evaluation of available tax credits. In effect, a private exchange acts as a portal to or partner with the public exchange. It is important to note, however, that no mechanism exists for the employer to provide pre-tax contributions toward individual coverage in the public exchange, as noted above.

If an employer wants to send full-time, active employees to the public exchange—either because the employer will not sponsor a group medical plan or because the employer coverage is deemed unaffordable by some benefits-eligible employees—the employer could adopt the approach described above for ineligible staff.

Garlitz is senior vice president of bswift (bswift.com), which offers software and services that streamline benefits, HR and payroll administration for employers and public and private exchanges nationwide.