Soon after the Affordable Care Act (ACA) was enacted, a school district in Illinois realized that unless it made some drastic changes, it would have a $3.5 million exposure to the Cadillac tax — a 40% nondeductible excise tax that will be imposed on health care coverage costs that exceed government thresholds beginning in 2018. After considering its options, the district, in cooperation with its collective bargaining units, created a health plan option that based enrollment on participation in a wellness program and completion of biometric screenings, annual checkups and a health risk assessment. The option encouraged participants to be health-conscious and ended up costing 30% less than the same plan without the wellness component. The district also fine-tuned all of its health plan options to encourage participants to be healthier. As a result, the district’s Cadillac exposure dropped to less than $350,000.
The school district isn’t an isolated case. Businesses can do a lot to avoid or reduce exposure to the Cadillac tax, and with compliance beginning in 2018, it’s time to start making changes.
What is the Cadillac tax?
The Cadillac tax, created under the ACA, is a 40% nondeductible tax on individual health plan costs that exceed $10,200 for individuals and $27,500 for families starting in 2018. (For certain groups like qualified retirees and participants in plans whose majorities are in “high-risk” professions, the initial amounts are $11,850 for individuals and $30,950 for families.) The excise tax generally applies to coverage under a group health plan that an employer makes available to employees and that can be excluded from employees’ gross income under Code Section 106(b). The tax also applies to employer contributions (and employee contributions made through a salary-reduction agreement), to health savings accounts (HSAs), flexible spending accounts (FSAs) and health reimbursement plans. Who will be affected
The number of employers who will owe the Cadillac tax in 2018 is expected to be relatively low at first, but increase as the gap widens between the government thresholds, which are annually adjusted and pegged to the consumer price index (CPI), and the actual health care plan costs, which reflect health care inflation and can be double or triple the CPI. The following chart illustrates how premiums can increase between 2015 and 2024 if an employer doesn't control its health cost increases. The chart assumes that health care costs will average 4 percentage points higher than the consumer price index.
Factors affecting cost
A factor that greatly affects health care costs is geography. For example, we researched the current cost of health care in Texas and projected the cost between 2014 and 2024. We found that the average plan in Texas may exceed the government threshold in 2019 if rate increases in plan costs align with expected health care cost trends. Pockets of high health care costs are widely dispersed in urban and rural areas, and include the Northeast and California.
Another factor is the health of the insured population. Even with a fairly average plan, an unhealthy group of participants will drive up medical costs and therefore the value of the plan. This is where wellness programs, discussed in the next section, can help.
Heavy users of health care predominate in some industries, including health care, public schools and the public sector. Workers in these industries may use health care services inefficiently, seeking treatments for full-blown problems that could have been prevented or handled earlier and less expensively. Efficient utilization focuses on prevention, early detection of problems and the monitoring of chronic conditions or diseases. We encourage employers to pass more costs on to heavy users — through higher co-insurance, copays, deductibles and out-of-pocket maximums — yet offer catastrophic coverage in case of unexpected severe illnesses.
What employers can control
Employers can manage costs in several ways: helping employees get healthy through initiatives like wellness programs, cost-shifting to employees, reducing benefits and narrowing options. Wellness programs are an investment that generates a strong return. The school district described previously has tamped down its average increases in health care costs to less than 2% over the past five years compared with an average health care trend rate of approximately 8% over the same period. According to the Centers for Disease Control and Prevention, approximately 70% of all health care costs can be avoided by a healthy lifestyle.
A major health insurer reports that a person controlling his or her diabetes — by taking medicine, going for regular exams, eating properly and so forth — costs close to $27,000 less in health care spending than a person whose diabetes isn’t controlled. With diabetes being so pervasive, that’s a big cost differential.
Some businesses are enforcing wellness programs and managing costs by requiring employees to complete a health risk assessment as a condition of health care coverage. They don’t penalize employees for the results, of course, but the results help educate employees about any conditions.
A large chunk of health care cost is generated by employees’ spouses and dependent children, so employers should look at helping their employees’ families be healthy too. The aforementioned school district required employees’ spouses to do the same things as the employees to qualify for a discount when enrolling in a health plan. In managing costs of dependent children, keep in mind that parents who participate in wellness programs are more likely to instill healthy behaviors in their children.
Wellness programs come at a price, but spending a few hundred thousand dollars is a bargain compared with spending millions of dollars on health care. Be sure to look at your ROI over a period of years.
Employers should also look at making their plans less rich. One way to do that is by shifting some of the cost to employees by fine-tuning deductibles, co-insurance, copays and out-of-pocket maximums, which will reduce the actuarial value of the plan.
Employers will also need to evaluate their plan offerings, including salary-funded FSAs and HSAs, which are factored into total health care costs. In addition, some businesses are narrowing the scope of physician and/or hospital networks or eliminating or reducing access to high-end plans.
NFPs: Get a plan for the Cadillac tax
Cadillac tax a bitter pill for health care sector
Consider Cadillac tax before signing on dotted line for M&A
Employers should communicate with employees about how the Cadillac tax will affect plan design so that there are no surprises in 2018 or beyond. Combining employee meetings with written or digital communication is ideal. At the very least, use open enrollment to talk about why things are changing instead of just what will be changing so that employees are more likely to understand the changes.
The school district’s changes took time to materialize. Even if you believe your business won’t be affected by the 2018 thresholds, the sooner you start making adjustments for the long term, the better positioned you’ll be to avoid or manage the tax.
Tax professional standards statement
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.