Cadillac Tax: Implications and Unknowns

Health industry experts cite the prevalence of rich healthcare benefits as a primary contributor to rising medical costs. These plans tend to insulate their members from the true cost of medical services since they either make no contribution or pay minimally out-of-pocket for care. Without the insight of cost or burden of payment, plan members are not motivated to seek out care at lower cost facilities or shop for the best value.

To incentivize employers and plan sponsors to nurture smarter healthcare consumers, the Patient Protection and Affordable Care Act of 2010 (PPACA) established an excise tax for high-cost health insurance plans. In addition, revenues from this tax will be allocated to support other aspects of the health reform law.

This new tariff is known as the "Cadillac Tax" in reference to luxurious plans that provide rich benefits such as low or non-existent copays and deductibles, extensive provider networks and coverage for expensive procedures such as in vitro fertilization. Starting in 2018, employers, health insurance issuers, and/or entities administering these high-cost plans will be subject to the tax that equals 40 percent of the aggregate value in excess of specified threshold limit.

The threshold limit that will trigger that tax is set at $10,200 for individual coverage and $27,500 for family coverage. For pre-65 retirees and individuals in high-risk professions (such as law enforcement and construction), the threshold amounts are $11,850 for individual coverage and $30,950 for family coverage.

Earlier this year, the Department of the Treasury and the IRS released Notice 2015-16, which included both guidance concerning several issues and a request for comments. Specifically, the Notice confirmed items that fall within the scope of "applicable employer-sponsored coverage" subject to the Cadillac Tax. These include:

• Total premiums paid by both employers and participants
• Insured or self-insured coverage
• Pre-tax employer and member contributions to HealthCare Flexible Spending Accounts (FSA), Health Reimbursement Accounts (HRA), and Health Savings Accounts (HSA)
• The cost of applicable coverage for health FSAs equals the sum of salary reduction contributions as well as any reimbursements that exceed salary reduction contributions, such as flex credits
• The cost of Employee Assistance Plans with counseling benefits, onsite medical clinics that offer only first-aid care, and wellness programs
• Applicable coverage refers to coverage in which a participant is enrolled as opposed to what is merely offered to the worker
• Multiemployer plans will be treated as other-than-self-only coverage for Cadillac Tax purposes

The IRS plans to exclude stand-alone dental and vision plans, long-term care, disability income insurance, and accident insurance from the Cadillac Tax.

For now, the cost is expected to be calculated following rules similar to those that apply to Consolidated Omnibus Budget Reconciliation Act (COBRA) premiums. With COBRA, premium cost is based on the cost of coverage for similarly situated non-COBRA beneficiaries. While COBRA rules require a breakdown of this cost (e.g., worker plus one, worker plus two, family, etc.), the IRS is considering the cost be segregated simply by self- and other-than-self-only.

And while COBRA regulations allow self-insured plans to use either the actuarial basis method or the past cost method when developing the COBRA premiums, it is likely IRS will limit the methodology to at least five years for purposes of the Cadillac Tax.

Unknowns
We are two and a half years away from implementation of the Cadillac Tax and there are still quite a number of unknown variables that could impact it. The single most glaring variable will be the result of the 2016 elections and whether or not there will be a concentrated push to repeal all or portions of the current healthcare legislation known as "Obamacare."

As we get closer to 2018, the current threshold amounts for the tax are expected to be updated and will be indexed for inflation thereafter. Threshold amounts also may be adjusted for certain demographic groups, such as by age and gender.

There are still outstanding questions regarding how the cost of HRA coverage will be determined. Methods that the IRS is considering include:

1. Basing it on the amounts made newly available to a worker each year
2. Combining all claims and administrative expenses attributable to HRAs for a particular period and dividing that sum by the number of participants covered for that period
3. Using the actuarial basis method

The Notice also requested feedback on whether the cost of applicable coverage should exclude
an HRA that can be used only to fund the participant contribution toward coverage, and/or an HRA that can be used to cover a range of benefits, some of which would not be applicable coverage.

Implications
The Cadillac tax is designed to offset PPACA expenditures, the largest of which include federal tax subsidies, Medicaid expansion, and small employer tax credits. The most recent estimates put revenues expected to be generated by the tax at $87 billion between 2018 and 2025.

One reason the Cadillac Tax is highly scrutinized is due to the possibility that it could increase tax revenues – and thus employer and worker expenses over time. In the first two years of the tax, the threshold amount will be indexed to the CPI plus one percentage point. Starting in 2020 and thereafter, the thresholds will be indexed solely to the Consumer Price Index. However, medical inflation tends to grow at a faster pace than overall inflation. To illustrate, the CPI-U's annualized change was 2.3 percent between April 2004 and April 2014, as compared to the 5.3 percent annualized change of the Milliman Medical Index (MMI) over the same timeframe. The MMI tracks the total cost of health benefits for an average family of four enrolled in a preferred provider organization (PPI) plan.

This difference in growth rates indicates that, over time, more plans will be increasingly subject to the Cadillac Tax, which will increase the employer cost of offering these high-cost plans. In fact, the potential exists for employers to face healthcare cost increases that exceed historical trends.

There is, of course, the distinct possibility that many employers will limit or scale back costly plan features to avoid this tax. Since these benefit-rich plans have long been considered the hallmark of strong compensation packages both in the public and private sectors, this change could represent a significant transformation in how workers are paid and how they purchase healthcare coverage.

Many of these changes in compensation practices have already started. In recent years, major retailers have stopped offering coverage to workers who work less than 30 hours a week. Moving forward, some employers may opt to eliminate healthcare coverage altogether and instead offer cash compensation so workers can purchase their plans via the Marketplace Exchanges – despite penalties set up to discourage this practice. However, even this compensation change will create greater tax revenue. In fact, the Congressional Budget Office (CBO) estimates that as much as 70 percent of revenue may be raised by the Cadillac Tax as a result of taxes on increased wages.

The upside to more workers becoming engaged in buying their own health insurance is that this could result in greater participation in exchange insurance pools and help drive more competitive premiums within the healthcare insurance market.

While the tax is still a few years out, it is critical that employers with union workers consider the cost of the Cadillac Tax when negotiating contracts that will extend beyond 2018.

The Cadillac Tax may also bump up against current benefit regulations to create a higher tax liability. Presently, employers are required to value and report liabilities for the cost of future benefits offered to retirees. These rules are administered by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB). Such regulations could create a scenario in which the 40 percent Cadillac Tax that an employer pays may also be subject to corporate income tax, depending on the taxable status of the plan insurer or administrator. The net result in this scenario is that every $1.00 in healthcare benefits the employer provides could cost $1.61 or more.

Employer, Union and Member Engagement
Historically, unionized workers and public-sector participants have enjoyed some of the most expensive healthcare plans offered by employers. But now, despite the fact that unions have spent decades launching legislative battles, lawsuits, and contentious negotiations with employers to win special protections for their members, the Cadillac Tax is poised to reverse many of those successes where healthcare coverage is concerned.

As a general rule, both unions and large employers oppose the Cadillac tax. Politically, one aspect that both Democrats and Republicans agree on is that the excise tax will motivate employers and workers to pay more attention on medical spending. To this end, many have begun offering highly specialized programs to help workers manage medical conditions and lower costs. For example, a disease management program can effectively target and manage participants with chronic conditions.

The Cadillac Tax is expected to have a significant impact in reducing the number of benefit-rich plans offered by employers. A 2013 survey by the International Foundation of Employee Benefit Plans revealed that nearly 17 percent of surveyed employers reported they were currently making changes to their insurance plans to avoid the Cadillac tax, while another 40 percent indicated they were seriously considering making changes.

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