The Health Insurance Act of 2003:
California's "Pay or Play" Universal Health Coverage

By John P. Krave and Pamela G. Gross
[December 2003]

Former SB 2, now the Health Insurance Act of 2003 (the “Act”), is a “pay or play” law requiring that employers pay a fee to the state to provide health insurance for each worker, and in some cases his or her dependent(s), unless the employer plays by providing coverage directly, in which case the fee is waived. Signed into law by former Governor Davis on Oct. 5, 2003, the Act is premised on the legislature’s findings that while most Californians obtain medical coverage through their work, fully 80 percent of uninsured Californians are working people or their families, most of whom work for employers who do not provide health insurance. The upshot is that in the relatively near future, with limited exceptions, California employers may no longer elect whether or not to provide health coverage for their workers, but rather will be required by law to do so.

Summarized below, are the relevant requirements and operation of the new law followed by a brief look at the controversy surrounding the Act, including public discussion of a state referendum to repeal it.

Who Must Comply?
Large employers, with 200 or more persons working in California, must comply by Jan. 1, 2006. Medium employers, defined as those with at least 20 but not more than 199 persons working in California, must comply by Jan. 1, 2007. However, the Act carves out those medium employers with at least 20, but not more than 49, workers, noting that they need not comply unless the State enacts a tax credit equal to 20 percent of the employer’s net cost of the fee. Small employers (i.e., those with 2 through 19 employees), are exempt from the Act. New employers, or employers not previously subject to the Act, must comply with all applicable provisions within one month of becoming subject to the Act.

As noted above, the overarching purpose of the Act is to ensure that working Californians and their families obtain health coverage. Accordingly, the Act prohibits the reduction of any protection already provided by collective bargaining agreements or more favorable employer-sponsored plans than those required by the state.

Who Is Covered?
Covered “enrollees” include persons who have worked at least 100 hours per month, for at least three months, for any individual employer. In addition, large employers (200 or more employees) must provide coverage for “dependents,” defined as a spouse, domestic partner, minor child of a covered enrollee, or a child 18 years or older who is dependent on the enrollee. However, “dependent” excludes any such individual who is covered by, or eligible for coverage by, another employer.

How Does the Program Operate?
A variety of State-sponsored entities, both old and new, will play a role in the operation of the program. These include the newly created State Health Purchasing Fund (the “Fund”), to be administered by the Managed Risk Medical Insurance Board (the “Board”), which also manages California’s Healthy Families program. The Employment Development Department (EDD) will also be involved. Employers are required to report employee information to the EDD and, further, to pay a fee to the Fund for each eligible worker (and dependent, if applicable).

The State program that provides enrollee/dependent health coverage when employers elect not to provide coverage directly will operate through a combination of employer fees and employee contributions, as established by, and paid to, the Fund under the Board’s oversight:

Employer Fee: For employers who prefer to pay the Fund will assess and collect a fee payable by the employer for each covered employee and, if applicable, dependents who are eligible for the program. Large employers, as defined above, pay for coverage for enrollees and their dependents, while medium employers pay only for enrollees but not for dependents. Employer fees must cover at least 80 percent of enrollee insurance costs.

Employers preferring to play (i.e., provide coverage directly), may, with satisfactory proof of compliance, apply for and receive a credit from the EDD against the fee that would otherwise be required. Health coverage offered through the Department of Managed Care (DMHC) or the Department of Insurance meets the requirement, as do collectively-bargained plans and multiple employer welfare arrangements, so long as maximum out-of-pocket costs to the enrollee do not exceed those available through DMHC-regulated preferred provider organizations. Certain types of common coverage, such as accident only, hospital indemnity, disease-specific or other limited plans do not qualify.

Enrollee Contribution: Enrollees are required to contribute no more than the remaining 20 percent for their Fund-provided health coverage. Moreover, the enrollee contribution for low income workers whose wages are less than 200 percent of the federal poverty guidelines (approximately $18,000 for an individual and $30,500 for a family of three) may not exceed 5 percent of wages. The employee contribution will be collected by the employer and submitted along with the employer fee.

The Fund will also set enrollee co-payments, coinsurance, and deductibles apart from which no out-of-pocket costs may be charged to enrollees and dependents for health benefits. In determining these costs, the Fund must, at least in theory, consider both (i) the effect of such costs as a possible deterrent to enrollees and dependents in obtaining appropriate, timely care, especially in cases of low or moderate family income; and (ii) the impact of out-of-pocket costs on the ability of employers to pay the required fees.

What Are the Penalties for Non-Compliance?
Employers bear full responsibility for compliance with the Act. An employer who fails to pay the employer fee will be liable to the Fund for payment of a penalty of 200 percent of the amount of any fee such employer would otherwise have owed, plus interest, for the period that coverage should have been provided to enrollees and, if applicable, dependents. Further, if the employer fails to collect or transmit the enrollee contribution, he will owe a penalty of 200 percent of the amount that should have been collected or transmitted. Employer misconduct also includes failure to report information concerning any employee to the EDD, presumably to avoid the fee for that employee. The various entities participating in the operation of the Program intend to cooperate to prevent such efforts to avoid the requirements of the Act.

Other employer prohibitions apply as well. An employer may not lawfully (i) designate an employee as an independent contractor or temporary employee, (ii) reduce an employee’s work hours, or (iii) terminate and rehire an employee if one purpose is to avoid the fees mandated by the Act for enrollee health benefits. The penalty for such further misconduct is 200 percent of the amount that the employer would have paid while the enrollee and any eligible dependents should have received coverage that the employer failed to provide.

An employer is also prohibited from inquiring as to the employee’s potential eligibility for public health benefit programs (e.g., Medi-Cal, Healthy Families) in an effort to transfer his responsibility to provide health coverage to a public program. However, the Board will obtain enrollment information from potential public program enrollees and, if applicable, will coordinate with the State Department of Health Services to facilitate enrollment.

The EDD will adopt regulations, possibly on an emergency basis, to ensure initial employer compliance with the provisions of the Act.

What Are the Obligations of Health Insurers Under the Act?
The Act also includes a set of reciprocal “Insurance Market Reforms” addressing applicable provisions of the California Labor Code and ensuring the availability of health benefit plans that permit compliance with employer requirements established by the Act. More specifically, upon the commencement of provision of health coverage by the Fund, marketers of health plans must “fairly and affirmatively offer, market, and sell” all of the insurer’s health benefit plans to all small and medium employers (as defined in both the Act and the Labor Code), including a guaranteed renewal of all such health benefit plans and restriction of use of any risk adjustment factor to risk categories of age, geographic region, and family composition.

The Insurance Reforms also specify that, on and after Jan. 1, 2006, insurers selling health plans to employers and to the Fund will make “reasonable efforts” to include, as preferred providers, county hospital systems and clinics, including referring providers to those entities, as well as other community clinics and safety net providers. This requirement appears to reflect a perceived need to support and maintain state resources in a time of budgetary crisis, in preference to private providers of health care services.

When Can Employers Require Employees to Contribute More Than 20 Percent of Coverage Cost?
An employer may require an enrollee contribution exceeding 20 percent of the cost of coverage if both of the following apply:

Additionally, enrollee out-of-pocket costs may be higher if the contract includes prescription drug coverage. The Board presumably will issue regulations to define the extent of permitted employee contribution under the circumstances.

How Will Public Health Coverage Programs Be Integrated?
The Board, to the extent permitted by federal law, will ensure that Healthy Families members continue to receive the same amount, duration, and scope of benefits presently received, including dental, vision and mental health benefits. In order to accomplish this objective, the Board will attempt to maximize federal participation and reduce state costs. Benefits will be provided through premium assistance for available, cost-effective employer-based coverage with a “wrap-around” benefit covering any gaps. Absent federal approval of a premium assistance program, the Board and stakeholders will explore other alternatives.

The Act commits the Board to a similar effort with regard to Medi-Cal, based upon federal assistance for aid to Medi-Cal recipients in paying premiums required under health coverage offered by the employer. As in the case of Healthy Families, a stakeholder board is envisioned, if necessary, to develop feasible alternatives for Medi-Cal recipients.

Mounting Controversy
SB 2 met with almost universal and unmitigated criticism from some sectors of the California press and a variety of organizations with an interest in the issue. An extensive study prepared for the California Chamber of Commerce (“Chamber Study”) found virtually nothing to say in the bill’s behalf. According to the Chamber Study, SB 2 will force large and medium-size firms to pay at least $5.7 billion to cover uninsured workers and their dependents. Meanwhile, workers will pay a sum approaching $1.5 billion for health coverage.

Opponents have made dire predictions regarding the likely negative economic effects of SB 2 on small and medium-size California businesses in particular. These effects include adverse impact on profits, payrolls, benefits offered, and competitiveness. More specifically, profit margins are expected to be reduced, resulting in a reduction of other employee benefits, a laying off of workers, closing down altogether, or moving to another state. In what many experts and lay persons alike view as California’s notoriously bad business climate, the concern is that still more businesses will flee the state. Indeed, the bill has been termed a “job killer.”

The Chamber Study also found that mandated employer-provided health coverage does not curb the upward spiral of health-care spending and insurance premiums. Rather, the opposite effect may result, given that it does little to reduce administrative overhead or unnecessary tests and service utilization. Further, SB 2 may provide employers with a disincentive to provide health care coverage through private insurers. In light of the small business exception, small businesses that presently elect to provide coverage will be at a competitive disadvantage with those that do not do so. Larger firms could determine it is cheaper to pay for state-funded coverage, while reducing costs of providing health coverage in-house, thereby deriving an increased competitive advantage over smaller firms. Firms with older, less healthy workers may also be more likely to pay into the state fund and cease to offer private health coverage.

The Chamber Study also reviewed the experiences of Hawaii and Massachusetts, states which also adopted mandatory employer provided health insurance. With respect to the Hawaii plan, dependent coverage was discouraged and wages were retarded in covered industries. The Massachusetts plan collapsed in the early 1990s, marked by political acrimony, an economic downturn, and a reduction of the plan’s original requirements. Massachusetts has since turned to federal matching funds to cover uninsured parents and children according to the Study.

Prior to execution, there was widespread hope that Governor Davis would veto SB 2. Now that the bill has become law, court challenges are expected based on the argument that the statute is preempted by ERISA. There is even talk of a possible voter referendum if necessary, in the hope of avoiding the above-enumerated, and other anticipated negative consequences of the Act.

FOR FURTHER INFORMATION, PLEASE CONTACT:

John P. Krave, Los Angeles, (213) 633-6873, johnkrave@dwt.com
Pamela G. Gross, Los Angeles, (213) 633-6874, pamelagross@dwt.com

This Health Law Advisory is a publication of the Health Law Group of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory is to inform our clients and friends of developments in health care law. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.

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