Potential State Applications of Section 125 Plans

1. Potential State Applications of Section 125 Plans Rick Curtis, PresidentInstitute for Health Policy Solutions SCI/NASHP/NGA Section 125 Plans Meeting June 20, 2008 Boston, MA

2. Under Section 125 "Premium-Only Plans", Employers can shelter Employee Premium Payments from taxation as personal income to the worker, i.e., from: • Federal income tax • FICA (Social Security and Medicare payroll tax) • Applicable state income or payroll taxes These plans are made available to wage and salary employees only, and are NOT available to: • Proprietors and self-employed individuals (who may deduct h.i. premium payments). • Non-employed persons (who may not deduct h.i. premiums).

3. This Section 125 "POP plan" simple option, does not entail complications of other flexible spending account plans (e.g., workers set aside amounts, they "use or lose"). To implement these POP tax sheltering plans (not ERISA plans), EMPLOYERS need to establish the plan, and • Deduct the amount to be paid for h.i. premiums from the workers (otherwise taxable) pay (payroll firms often do this for smaller employers), and • Verify that the full amount thus "sheltered" goes to health insurance premium payments.

4. Premium payments that can be sheltered include employee payments: • Towards employer group coverage (employer contributions are automatically "sheltered", i.e., they are not treated as income to the worker). • For individual health insurance that complies with certain requirements. • For COBRA coverage from a former employer-- Where there are worker "earnings" from which to deduct payments.

5. Sheltering these payments AUTOMATICALLY reduces the premium cost realized by the worker. • That is, the worker's take-home pay reduction for premium payments reflects the reduction in taxes (because taxable income and associated tax with-holding amounts are reduced) • Immediate federal tax savings to the worker are often substantial (depending on income). • For example, for a family of four at 250% FPL, 22.7%* of the worker-paid premium • For single adult at 500% FPL, 32.7%* of the worker-paid premium. *Not including EITC, employer FICA, state tax effects.

6. Who can benefit (and not)? States can extend use of POP plans to reduce health insurance costs of many individuals not otherwise eligible for such Section 125 plans, I.e., wage and salary workers and dependents, who are: • Offered employer coverage but not a 125 plan (some small-firm workers) • Employed by a firm that does not offer group coverage • Are ineligible for their employer's group plan. (The latter 2 groups constitute a significant share of the uninsured population). Not a financing source for coverage of the poor, who should generally decline participation in these plans (participation could reduce net income for poor parents receiving EITC).

7. Range of State applications for different policy contexts and goals Individual Mandate / Near-Universal Coverage / Shared Responsibility (e.g., Mass.): • Requiring employers to make POP plan available to all workers makes sense. • Substantially reduces (net) costs of coverage for many individuals, an important carrot/silver lining for those who could afford but do not now have coverage and for those already insured workers without POP plans. • Can significantly reduce net state subsidy costs, especially for “state only” tax credits/premium assistance for populations above federally-matchable income ranges(e.g., for older individuals buying age-rated coverage) • Can ease the transition for healthy insured individuals with underwritten low individual rates to coverage with no health rating (note that individual plans qualify for 125 sheltering only if they qualify as HIPAA/COBRA “group” plan complaint—e.g., no health rating).

8. Range of State applications for different policy contexts and goals Voluntary State Coverage initiatives, e.g., subsidized coverage for uninsured small-firm workers, such as the Maryland Plan. E.g., condition of program participation requirement that employers offer POP plan to all participating worker: • Reduces coverage costs for higher income workers. • Can mitigate state subsidy and/or worker costs for modest income/subsidized workers. For this or other applications, note that a State exchange/connector/choice pool can make it easy for employers to provide POP plan sheltering while workers have choice of competing plans— I.e., by providing the employer with: • Single “list bill” for respective employee premium amounts to be withheld from pay/sheltered. • Ongoing assurance that these tax-sheltered amounts go for health insurance.

9. Range of State applications for different policy contexts and goals State measures to reduce health insurance costs for workers (group or individual plan) not now eligible for a POP plan.Either state requirements, incentives, information and/or facilitating policy changes for employers to adopt/extend such plans: • Could reduce net coverage costs for a number of insured (voters). • Might reduce costs enough to induce some insured (higher income) persons to participate. • Might be a vehicle for achieving some desired individual market rules or options (again, note that any individual plans would have to be available with no health rating).

10. Concluding Observations Be Aware of Potential Downside Risks • For example, making individual coverage very attractive and affordable for higher income workers could lead some employers to drop group plans and contributions, leaving heretofore insured lower-income workers uninsured. And Keep Your Eye on the End Game. If your state wants to achieve coverage of all: • Remember that extending 125 plans to all workers can be a carrot for acceptance of individual, as well as shared responsibility. (If you give the carrot away too early, it will already be eaten when you need it.)