Improving Affordability of Insurance for Consumers by Eliminating the Firewall Between Employer and Individual Markets

Abstract

• Issue: The Affordable Care Act (ACA) includes a “firewall” provision that prohibits workers with an affordable offer of employer-sponsored insurance (ESI) from receiving premium tax credits in the individual insurance marketplace. Eliminating the firewall could help certain low-income workers find more affordable coverage options in the marketplace.
• Goals: Simulate the effects of removing the firewall on health insurance coverage, household premiums, and overall costs to federal and state governments.
• Methods: We use the Urban Institute’s Health Insurance Policy Simulation Model to estimate the effects of firewall removal.
• Key Findings and Conclusion: Eliminating the firewall leads to 1.8 million people (1.2%) shifting out of ESI, with many finding more affordable coverage in the marketplace (and a few in Medicaid) and a reduction of 1.4 million uninsured people. However, the tax subsidies for ESI are large enough that most of those with ESI benefit by staying enrolled in that coverage. Removing the firewall would save households $4.4 billion in premiums and other health care spending. The federal government would increase spending by $17.8 billion, primarily for marketplace premium tax credits. This would represent an increase of 18 percent in federal spending on premium tax credits.

Introduction

The U.S. tax system is structured to enhance the affordability of private health insurance coverage through tax-based subsidies. In 2022, about 156 million people with employer-sponsored insurance (ESI) benefited from excluding the cost of ESI from their taxable compensation.¹ Additionally, approximately 13.5 million people were enrolled in subsidized nongroup coverage through the Affordable Care Act’s (ACA) health insurance marketplaces, available to those without access to an affordable offer of ESI.² For 2022, the Congressional Budget Office estimates that the federal government spent $316 billion on ESI tax subsidies and $89 billion on marketplace subsidies.³ The generosity of these subsidies varies between the individual and employer markets and by income.

The ESI tax exclusion effectively offers larger subsidies to those in higher tax brackets, as the marginal tax rate they would have to pay if health insurance coverage were taxed is higher. The tax exclusion is also proportional to the cost of coverage: the higher the cost of coverage, the larger the amount excluded. For that reason, the tax exclusion encourages many employers to offer more comprehensive benefits and wider provider networks that increase the cost of coverage. However, not all employers offer generous coverage. A small share of employees are offered plans that meet the minimum value required by law: a plan that covers just 60 percent of expected costs, although the exact number of employees with such plans is uncertain.⁴

The ACA’s marketplace premium tax credits (PTCs) work in the opposite manner to the ESI tax exclusion, offering larger premium subsidies to enrollees with lower incomes. Moreover, enrollees with incomes below 250 percent of the federal poverty level (FPL) are also eligible for cost-sharing reductions that substantially increase the generosity of the coverage; available plans may cover 94 percent, 87 percent, or 73 percent of expected costs. Additionally, expected employee contributions in ESI are set by individual employers, but the marketplaces offer standardized, income-based subsidies, with enrollee contributions set by formula. Depending on the expected employee contribution for ESI, some low-income employees may be able to purchase similar or better coverage in the marketplace for lower out-of-pocket premiums than in ESI.

How the Firewall Limits Access to Premium Tax Credits and More Affordable Coverage

The ACA includes a “firewall” provision that prevents workers from receiving PTCs and cost-sharing subsidies in the marketplace if they had an affordable offer of ESI. This provision was intended to keep the employment-based system intact. Under the ACA, ESI is considered affordable if the employee’s premium contribution is less than 8.39 percent of household income in 2024.⁵ However, many lower-income workers could access more affordable coverage via the marketplaces, where premiums are limited to up to 8.5 percent of household income under current law.⁶

Employees with household income less than 150 percent of FPL would be eligible for $0 premium silver plans with generous cost-sharing reductions on the marketplace if the firewall were removed, and employees with household income at 200 percent of FPL would pay a premium of 2 percent of income for a silver plan with additional cost-sharing reductions.⁷ Right now, these lower-income employees cannot access marketplace coverage if their employer offers affordable ESI, even if marketplace coverage would be less expensive or more comprehensive. For example, in 2023, a single worker with income of $25,000 (172% of FPL) would pay $220 (0.9% of income) for the entire year for marketplace coverage after receiving a PTC. But an ESI offer requiring the worker to pay $2,250 (9% of income) for coverage would trigger the firewall and disqualify the worker from receiving any PTC.

Some workers with an ESI offer that is deemed affordable under the ACA remain uninsured because of the firewall policy. Dropping the firewall could allow these adults to access marketplace coverage with PTCs. Additionally, some people who are barred from receiving PTCs by the firewall policy choose to pay full price for a private nongroup plan rather than enroll in ESI. If the firewall were eliminated, these people could also access PTCs and reduce their out-of-pocket premium costs.

Removing the firewall goes further than recent administrative changes to Internal Revenue Service (IRS) regulations that eliminated the “family glitch.” Prior to those changes, entire families were barred from marketplace subsidies if one family member’s employer offered an affordable individual-level plan.⁸ The IRS now has an affordability test for family coverage that allows dependents to receive marketplace subsidies if an employer offer of family coverage exceeds 8.39 percent of their household income in 2024.⁹ However, the employee may still be barred from marketplace subsidies if individual ESI coverage is considered affordable, and dependents may still be barred if family ESI coverage is considered affordable. Getting rid of the firewall opens access to marketplace subsidies and prevents families from having to enroll in separate plans.

Eliminating the Firewall Would Allow Some Lower-Income Employees to Attain Generous Coverage

Many employers offer comprehensive ESI coverage with low deductibles and copayments that is comparable to gold or platinum plans available in the marketplace in terms of actuarial value.¹⁰ However, not all employers offer such benefits, and evidence suggests the generosity of ESI has been eroding over time.¹¹ In contrast, marketplace plan premium tax credits and plan generosity are defined by law. Therefore, some low-income employees whose employers offer less generous coverage with high employee premium contributions may be able to find more generous coverage for a lower cost on the marketplace if the firewall were removed.

This brief estimates the effects of dropping the firewall on health insurance coverage and spending by households, states, and the federal government. We assess changes in coverage and household spending by income. We also conduct sensitivity analyses lowering the affordability threshold for ESI to 4 percent of family income, since some policymakers have advocated a reduction in the threshold as an alternative to the complete elimination of the firewall.¹² (For more details, see “How We Conducted This Study.”)

Coverage and Cost Impact of Eliminating the Firewall

If the firewall policy were eliminated in 2024, ESI coverage would fall from 149.9 million to 148.1 million, meaning 1.8 million individuals under age 65 would drop or lose ESI (Exhibit 2). This loss of ESI would be offset by 2.9 million people gaining private nongroup coverage, primarily through the marketplace. About 0.2 million people, mostly children, would gain coverage through Medicaid or the Children’s Health Insurance Program (CHIP) when family members enrolled in the marketplace. Overall, 1.4 million fewer people would be uninsured. ESI coverage would fall by 1.2 percent, private nongroup coverage would increase 12.5 percent, and the number of uninsured would decrease by 5.7 percent (Exhibit 2).

As shown in Exhibit 2, ESI losses and gains of private nongroup coverage would be concentrated among nonelderly individuals with incomes between 138 percent and 400 percent of FPL. This is driven by the availability of marketplace PTCs, which offer maximum savings for individuals and families in this income range. The uninsured rate would also fall for this group because some of the uninsured would be newly eligible for PTCs.

Overall, approximately 0.5 million people with family incomes between 138 percent and 200 percent of FPL would move out of ESI, and 0.8 million would gain private nongroup coverage, primarily through the marketplace. A smaller number of people, mostly children (0.1 million) with incomes between 138 percent and 200 percent of FPL would enroll in Medicaid, while 0.4 million fewer people would be uninsured than under current law.

For people with incomes between 200 percent and 400 percent of FPL, we estimate 0.9 million would move out of ESI, 1.6 million would gain private nongroup coverage, and 0.8 million fewer would be uninsured.

Eliminating the firewall would save households $4.4 billion per year in premiums and other health care spending (Exhibit 3). These savings would result primarily from the higher subsidies received by people enrolling in marketplace coverage. Employers would reduce their spending on premium contributions by $8.1 billion as employees shift to marketplace coverage, and providers would save $1.5 billion on providing uncompensated care as the uninsured rate falls. The costs of providing lower-income workers with more affordable coverage would fall primarily on the federal government, which would increase spending by $17.8 billion, mainly for marketplace PTCs. State governments would also spend an additional $460 million on Medicaid and marketplace coverage, but this would be offset by a $520 million reduction in uncompensated care as a result of the reduction in the uninsured rate.

Some individuals who would gain eligibility for PTCs are already enrolled in unsubsidized nongroup coverage, often outside of the marketplaces. Many would switch to marketplace coverage with PTCs. For simplicity, we do not distinguish between types of nongroup coverage in Exhibits 1 and 2. However, these savings are included in the total household savings shown in Exhibit 3.

Similarly, some of the uninsured under current law would become newly eligible for PTCs after elimination of the firewall and enroll in marketplace coverage. This group would see an increase in total household spending for premiums and out-of-pocket costs relative to current law, an increase in federal and state spending for PTCs, and a reduction in uncompensated care costs for states and providers. These changes are included in the total net household savings shown in Exhibit 3.

Sensitivity Analysis

To assess the impact of changing variables on the outcome, we conducted a sensitivity analysis reducing the affordability test to 4 percent of household income. This was chosen because some policymakers have proposed reducing the firewall rather than eliminating it. Some have proposed reducing the affordability threshold to 8.5 percent, but this approach has negligible impacts, so we simulated the effects of a larger reduction.¹³

Compared to eliminating the firewall, even a substantial lowering of the threshold to 4 percent has only moderate effects on coverage and savings, with only 350,000 nonelderly individuals shifting out of ESI and 330,000 fewer uninsured (data not shown). The policy showed just $720 million in increased household savings and a $3.4 billion increase in federal spending (data not shown). Eliminating the firewall entirely has much larger effects on coverage and household spending.

Discussion

Eliminating the firewall would allow certain low-income workers to access more affordable health insurance coverage through the marketplace. While many employers offer generous ESI coverage with low employee contributions, this is not true for all employers. Some employers with large shares of low-wage workers offer plans that meet the minimum value required by law. Also, deductibles and premiums for ESI have been increasing over time.¹⁴ This puts more financial burden on low-income employees to afford premiums and cost sharing and makes marketplace plans with newly expanded subsidies more attractive. We find that, if the firewall were eliminated, 1.8 million people would drop or lose ESI coverage, with many gaining coverage through the private nongroup market.

In addition, removing the firewall would save households more than $4.4 billion per year in premiums and other health care costs and would lead to 1.4 million fewer uninsured. However, the effects of removing this policy may be smaller than many policymakers expect. We find only a 1.2 percent reduction in ESI coverage, in part because the ESI tax subsidy is still substantial, making it beneficial for most employees to stay in ESI even with the elimination of the firewall. For example, many employers offer generous premium contributions (that are tax-subsidized), keeping expected employee contributions well below the ACA’s affordability threshold of 8.39 percent of income in 2024.

Overall, eliminating the firewall would help some lower-income workers, particularly those with family incomes between 138 percent and 400 percent of FPL, save money on health insurance premiums and out-of-pocket costs. It also would help workers whose families are enrolled in marketplace coverage select a single health plan with a combined family deductible and out-of-pocket maximum. Finally, workers who have purchased private nongroup coverage on their own rather than enroll in their employer plan, or who are uninsured because of the firewall policy, would be able to access marketplace subsidies.

Dropping the firewall provision would also simplify the application for marketplace coverage, which has the potential to enhance enrollment among those who are already eligible for PTCs beyond what we’ve presented here. The current application requires applicants to collect information from their employers and make attestations — under penalty of perjury — to facts that some people have trouble understanding regarding the amount of employee contributions for premiums. Getting rid of the firewall would remove these steps and simplify public outreach and education about marketplace coverage.

Conclusion

Eliminating the Affordable Care Act’s firewall would increase savings to households and reduce the number of uninsured. While the accompanying changes in employer-sponsored insurance coverage were relatively small, people currently uninsured because of the firewall policy could gain marketplace premium tax credits to help them afford coverage. Removing the firewall also would allow employers to save $8.1 billion in premium costs, much of which would be returned to workers over time in the form of higher wages. The costs would fall primarily on the federal government, which would increase spending by $17.8 billion, primarily for marketplace PTCs. State governments and providers would also benefit from lower uncompensated care costs.