A Hard Pill to Swallow
Why healthcare reform poses serious threats to staffing
By George Reardon
President Obama and the previous Congress have put in place a comprehensive health insurance law that will roll out over four years and beyond, with its most dramatic features taking effect at the beginning of 2014. There will be winners and losers depending on where you are in the staffing landscape. Attorney George Reardon explains the implications and how staffing firms can prepare for what lies ahead.
In 2010, the U.S. Congress passed what is commonly referred to as healthcare reform. The legislation, called the Patient Protection and Affordable Care Act (PPACA), has penalty and non-discrimination features that can pose serious risks to staffing firms.
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In short, the legislation mandates that companies over a certain size either offer qualifying coverage for their employees or pay a penalty, starting in 2014. Many staffing executives do not yet appreciate the size of the penalties that PPACA will impose on their firms if the “monthly measurement” language of the PPACA statute is followed without mitigation by regulations.
Here’s how to estimate (roughly) the annual before-tax equivalent of the penalties for a typical office/clerical/industrial non-day-labor temporary staffing firm that does not offer comprehensive health coverage to all employees:
- To estimate the number of full-time assigned employees (those averaging at least 30 hours a week): Take 60 percent of the number of workers assigned for any length of time during a typical month. (For professional lines, use at least 75 percent).
- Add the number of your full-time, in-house staff (even if they are insured).
- Subtract 30.
- Multiply the result by $2,000. This is your estimated total after-tax cash penalty for 2014, assuming your current level of business.
- To calculate your before-tax penalty, “gross up” the total after-tax cash penalty according to your tax situation: The gross-up factor depends on your firm’s marginal (highest) corporate income tax rate: Gross-up factor = 1/(1-marginal tax rate). So, for a firm paying a marginal rate of 38 percent: the Gross-up factor = 1/(1-0.38) = 1.613. For that firm, the before-tax equivalent would be 61.3 percent higher than the cash penalty, and the before-tax equivalent of the annual penalty would be $3,226 per full-time employee for 2014.
The before-tax equivalent of the penalty is what matters the most, since that is the amount of additional gross margin that you must earn in order to just break even on paying the nondeductible penalties.
The before-tax hourly cost of the PPACA penalty for a full-time employee ranges from about $1.00 per hour (for a 40-hour-per-week employee of a non-taxpaying staffing firm) to about $2.00 per hour for a 30-hour-per week employee of a large taxpaying staffing firm.)
For the largest staffing firms, penalties for 2014, under the unaltered monthly calculation method prescribed by the statute applied to their current employment and assignment patterns, would each
be tens of millions of dollars or more. (For an example of a midsize company’s potential penalty, see sidebar at end of story.)
The American Staffing Association, in cooperation with other groups, is advocating for PPACA regulations that would partially mitigate the penalty calculations. One possibility would be to impose a minimum initial work period before assigned workers could be counted as full-time employees. Along similar lines, the Treasury Department and IRS have solicited public comments on an elaborate “look-back/stability period safe harbor” rule that would help staffing firms avoid paying penalties for the most transient assigned workers. It is not clear how much latitude regulators will have to mitigate or waive penalty provisions that appear to be hard-wired in clear statutory language, especially when such modifications would reduce tax revenues.
A curative amendment to the law itself would also be very hard to obtain. Even if opponents of the legislation were to occupy the presidency and hold simple majorities of both houses of Congress after the 2012 elections, supporters may retain the legislative ability to block statutory amendments.
Changing the Landscape
The PPACA penalty provisions favor small staffing firms over large ones. Firms with fewer than 50 full-time employees are completely exempt from the penalties. Firms with 50 or more full-time employees are subject to the penalties but can still exclude 30 full-time employees from the penalty formula, a “carveout” worth about $90,000 per year in pre-tax dollars. These two rules can eliminate or significantly reduce penalties for a small firm, but truly large staffing firms will effectively pay the penalty on every assigned worker, because they have more than 30 staff employees, fully exhausting the “carveout” before they could attribute any of it to assigned employees.
Most staffing firms price their services with pay-to-bill markup percentages or flat bill rates. Neither of those methods automatically adjusts for burden increases. You can get the larger gross margins that you need to pay the PPACA penalties by charging customers more or by paying assigned employees less. But, without proactive changes to your normal wages or bill rates, the default source of the penalties would be your existing margins.
A staffing firm paying these penalties would have a serious competitive disadvantage against firms that can provide the same employees without paying penalties. Staffing buyers are increasingly price-driven,
as more and more customer buying decisions are made or influenced by price-driven purchasing departments and vendor management systems. If staffing firms attempt to pass the penalty costs to their customers, the non-financial reasons for using them instead of no-penalty or low-penalty firms would need to be very compelling.
If penalty-paying firms try to recoup penalty costs by lowering the assigned employees’ wages instead of raising prices, they face economic choices by their assigned employees. Staffing firms compete for employees as well as for customers. The temporary employee asked to absorb a penalty through lower-than-market wages can instead seek work at full market wages directly with the client or with a staffing firm that does not pay penalties or that does not try to recover penalties from wages.
The current legislation does provide ways for staffing firms to reduce or minimize their penalties, which we are in the process of researching for implementation after the related regulations are finalized.
The legislation also presents staffing firms with opportunities for helping their customers solve penalty and discrimination problems under the law by payrolling currently uninsured segments of customer workforces, thus leaving the customer with a fully insured workforce that will be relatively penalty-free. This kind of sale will require an understanding of how PPACA will affect customers and the ability to craft and communicate staffing solutions for them.
The labor costs of PPACA fall more heavily on staffing firms than they do on most staffing customers, a fact that is likely to suppress aggregate demand industry-wide by narrowing the cost advantage of using temporary employees. Staffing firms will need to identify new cost savings and other reasons for using temporary employees to compensate for this effect.
Staffing firms should be deciding now whether, to what extent, and how (administratively) they will pass PPACA penalty costs on to customers.
Staffing firms that plan to pass any PPACA penalty costs on to customers should be addressing how to do that in all contracts or proposals that will be effective on or after Jan. 1, 2014. Because many such contracts are already being negotiated, this is an issue for which staffing firms should already be proposing effective contract language. No matter how the financial issue is resolved, it is most important to avoid bitter disputes with customers over this issue. Addressing this problem well in advance may also prevent customer accounts from being put out to bid as 2014 approaches.
Many existing staffing contracts require customers to absorb newly imposed or increased burden costs that are directly related to their assigned employees. The exact wording of those contracts may or may not work to pass along PPACA penalties. Worse, as many staffing firms have discovered with increased unemployment insurance costs, customers presented with mid-contract rate increases may simply refuse to pay them or stop using the services, because most staffing contracts are not exclusive and do not commit the customers to do any minimum amount of business.
Billing the penalties for certain employees to customers could get very complicated. You will not know whether an employee will generate the penalty for a particular month until the employee has worked at least 120 or 130 hours in the month. Practically, most staffing firms will determine after the fact which employees qualified as full-time. Penalty-generating full-time employees may have to be billed in two separate pieces, with the penalty billing lagging the regular weekly billings by one to five weeks. This complication will further aggravate the accounting and invoicing problems that staffing firms already have with their customers and that are already complicated by the involvement of vendor management system firms and subcontracting relationships.
Staffing firms could avoid the administrative problem of billing customers for PPACA penalties by completely “socializing” the penalty costs — that is, by raising the bill rates for all of their full-time and part-time assigned employees by the overall average before-tax penalty equivalent. That would eliminate the need for a separate billing of PPACA penalties generated by particular temporary employees. However, economic principles make this risky, because it invites harmful price selection by customers and VMS firms.
Overall, customers and VMS firms would tend to use more of the underpriced full-timers and fewer of the overpriced part-timers, effectively reducing the staffing firms’ overall margins and launching a spiral of recalculations and increases of the socialized penalty costs. The endpoint of this pricing spiral would be selling only full-time employees who are loaded with the full penalty costs anyway.
Other administrative issues might include: how to measure the tax gross-up portion of the penalty, how to persuade clients to pay the gross-up, apportioning penalties for employees who work for multiple customers, and defining customer audit rights related to the penalties.
Staffing firms will also need to keep a close eye on regulations pertaining to non-discrimination. The new rule that non-grandfathered insured health plans may not discriminate in favor of highly-paid employees was scheduled to become effective on Jan. 1, 2011, but is awaiting implementing regulations. PPACA requires these regulations to be similar to the long-standing tax regulations for self-insured medical reimbursement plans. When those regulations appear, it is doubtful that they will permit the traditional coverage pattern of staffing firms — comprehensive, subsidized coverage for in-house staff and no coverage or self-paid mini-med plans for assigned workers. Some professional assigned workers are provided coverage, but they tend to be highly paid, so, unless the staffing firm assigns only such professional employees, discrimination in favor of the highly-paid may still be a problem.
The penalties for discriminatory insured plans will be so high ($100 per day per non-favored employee) that paying them or risking paying them will not be viable choices. Further, insurance companies will also be directly subject to these anti-discrimination regulations, so, even if staffing firms are willing to take a legal and financial risk with the traditional coverage pattern, insurance companies may refuse to underwrite such plans. Self-insured plans, though not subject to the new regulations, may be subject to heightened and even retrospective scrutiny under the long-standing regulations on self-insured plans.
The much-publicized interim exemption of many mini-med plans from the restrictions on benefit limits is helpful for maintaining some coverage for assigned employees prior to 2014 but does nothing to fix the industry’s long-term potential problem with the new anti-discrimination rule.
The American Staffing Association is seeking regulatory approval for the traditional coverage pattern of staffing firms as a reasonable and nondiscriminatory pattern that has been used without government objections for a long time in the self-insured environment. That approval may be difficult to obtain from the administration’s bureaucracy, because it would be perceived as impeding the expansion of comprehensive coverage. If the traditional pattern is not approved, staffing firms, ironically, may become practically unable to continue sponsoring group health coverage for their in-house staff employees.
George Reardon is special counsel and member of the Contingent Workforce Practice Group at Littler Mendelson, P.C., the largest employment and labor law firm exclusively representing management in the United States. He was formerly general counsel of Kelly Services Inc. and Adecco Group North America.
For more details on the features of PPACA, read our sister publication, Staffing Industry Report (October 2010).
Play or Pay Case Study
A commercial staffing firm with 50 full-time staff employees that assigns 800 different temporary employees during a typical month and that does not offer comprehensive health coverage to all of its full-time employees.
|800 temporary employees||800|
|Assume 60 percent are full-time under PPACA||x0.60|
|Estimated number of full-time temporaries||480|
|Number of full-time staff employees||+50|
|Total number of full-time employees||530|
|Minus 30-emplyee "carveout"||-30|
|Annual PPACA penalty rate for 2014||x$2,000|
|Estimated 2014 PPACA penalty||$1,000,000|
|Gross-up Factor (for a 38% marginal tax rate)||x1.613|
|Before-tax equivalent of PPACA penalty for 2014||$1,613,000|