Free Rider Penalty
Beginning January 1, 2014, if large employers do not provide "adequate" and "affordable" health coverage to their employees (and their dependents), they may be subject to a Free Rider Penalty. A "large employer" is defined for this purpose as one having an average of 50 or more full-time (or full-time equivalent) employees during business days of the previous calendar year. In order to determine the number full-time equivalent employees, the employer would add:
- Number of full-time employees working 30+ hours per week, plus,
- Hours worked by part-time employees during the month divided by 120.
The result is the number of full-time equivalent employees. Certain seasonal workers may be excluded from the calculation.
The law will exact a monthly penalty on the employer in either of the following circumstances:
Employer does not offer any coverage
One penalty applies if the employer does not offer health coverage to full-time employees (and their dependents) and at least one full-time employee (30+ hours per week) receives a premium tax credit to purchase coverage through an Exchange. (Employees with household income of up to 400% of the Federal Poverty Level are eligible for a premium tax credit.) This monthly penalty is 1/12 times $2,000 times the number of full-time employees. The first 30 employees are excluded from the calculation of the penalty.
Employer's coverage is "inadequate" or "unaffordable"
A separate penalty applies if the employer does offer health coverage to full-time employees (30+ hours per week) and their dependents, but the coverage is either inadequate or unaffordable and at least one full-time employee receives a premium tax credit to purchase coverage through an Exchange. Coverage is considered inadequate if the plan pays less than 60% of the allowable costs covered by the plan. Coverage is considered unaffordable if the premium contribution to participate in the employer's plan costs the employee more than 9.5% of the employee's current W-2 wages from the employer. This monthly penalty is 1/12 times $3,000 times the number of full-time employees receiving a premium tax credit, capped at the maximum penalty the employer would pay if it did not offer coverage.
Free Rider Penalty Hot Topics & FAQs
- Safe Harbor Definition of Income For Free Rider Penalty
The language in the Health Care Reform law establishing the Free Rider Penalty provides that coverage is affordable if the employee does not have to pay more than 9.5% of household income in order to receive employee-only coverage. The reference to “household income” raised concern for employers who do not have access to information about the employee’s household income. To address this concern, the IRS has announced that future guidance implementing the Free Rider Penalty is expected to provide an affordability safe harbor for employers. Under this anticipated safe harbor, coverage will be considered affordable if the coverage is otherwise adequate and the employee portion of the employee-only premium for the employer’s lowest cost coverage option does not exceed 9.5% of the employee’s current W-2 wages from the employer. For purposes of the premium tax credit, an employee will be considered to have access to affordable employer-sponsored coverage (and therefore would not qualify for a premium tax credit) if the employee has to pay more than 9.5% of their household income for employee-only coverage.
- Will grandfathered plans be subject to the Free Rider Penalty?
Answer: Employers, not plans themselves, are subject to the Free Rider Penalty. There is no exemption for sponsors of grandfathered plans. Thus, if the grandfathered coverage is inadequate or unaffordable, the employer may owe a penalty.
- How would one calculate whether a plan's coverage is "inadequate"?
Answer: Agency guidance is expected to clarify how to perform this calculation. However, the following may provide a better understanding of the general concepts likely to be involved. Coverage is adequate if the actuarial value of the affordable coverage is at least 60%. Actuarial value is the amount the plan will pay toward allowable costs. The participant makes up the remainder of the costs in the form of cost-sharing. One possible way to calculate actuarial value is to divide:
- Allowable costs minus cost-sharing, by
- Allowable costs.
The allowable cost is the negotiated amount (e.g., after applying network discounts or usual, customary, and reasonable payment policies for out-of-network coverage) on which payment is based for health care services covered by the health insurance policy or self-funded plan (eligible expenses).
It's currently unclear the extent to which insurance premiums may be taken into consideration. Guidance is also expected to clarify whether employer contributions to a Health Savings Account may be taken into account.
- Does a high deductible health plan provide adequate coverage?
The plan sponsor would need to perform the calculation to determine whether the plan's actuarial equivalence is at least 60%. However, as a rule of thumb, high deductible health plan coverage offered in connection with a Health Savings Account often has an actuarial value of approximately 65%.
- How much is 400% of the Federal Poverty Level?
Click here to link to the latest Federal Poverty Levels as established by the federal government. The following are examples of 400% of the Federal Poverty Level in 2011:
- Individual: $ 44,680
- Family of 2: $ 60,520
- Family of 4: $ 92,200
- Family of 6: $ 123,880
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Additional Resources
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Employer responsibilities and choices
What do you do with your health plan now?
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Calculator
To estimate the amount of Free Rider Penalty you may owe
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Premium Tax Credit
Additional information about the availability of a premium tax credit
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Federal Poverty Level
Link to the latest levels as established by the federal government
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Free Rider Penalty Flowchart
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American Fidelity Assurance Company does not provide tax or legal advice.
