Starting in 2016, push comes to shove for small businesses under the Affordable Care Act, better known as Obamacare. As of January 1, small businesses, broadly defined as firms with 50 to 100 full-time employees, must comply with the ACA’s employer mandate and provide qualified health insurance to their workers or face stiff penalties. But this requirement poses a big threat to the financial stability of small employers—and not for the reasons you might think.
Obamacare includes a myriad of regulatory incentives and exemptions that define the parameters of the employer mandate. However, these have inadvertent consequences. Most important, exemptions in the ACA encourage small firms to self-finance their health care plans—that is, pay their workers’ health care bills directly, rather than covering them through a traditional insurance policy. Most large companies in America (above 3,000 employees) engage in self-funding, but that is done now by only about 16% of small companies of between 50 and 100 employees. According to my research, that number is set to rise.
It’s understandable that small companies see self-funding as the superior option. By financing their own health care plans, they stay exempt from the community rating requirements that restrict how much insurers may vary premiums based on factors like age and smoking status; they also stay exempt from the federal and state taxes on most health care premiums that are paid to traditional insurers.
But these benefits pose significant risks for small businesses. While a big company usually has a diversified employee base and financial resources that can help absorb substantial overruns in health care expenses, a small company has neither. One big claim can wipe out a small company.
To limit their risk, small companies usually purchase stop-loss insurance, which kicks in when an employee incurs unusually high medical expenses. But here’s where things get dangerous: The handful of large reinsurers that sell stop-loss insurance do not typically require small businesses to constrain their health care costs. In other words, if a reinsurer believes a small firm has an expensive health care plan, it will simply charge a higher premium with a higher deductible. Since stop-loss policies are issued on an annual basis without guaranteed renewal, an unexpected rise in the health care costs at a small firm can lead to much higher premiums the following year or an abrupt cancellation of the policy.
Read the full post at Forbes.
Bob Pozen is a Senior Lecturer at the MIT Sloan School of Management.