What is an Insurance Exchange?

January 30, 2013

The health care reform law has popularized the term “insurance exchange.” Insurance exchanges are organized marketplaces that bring together health insurers and consumers in a “managed competition” setting. The sponsor of the exchange would set “rules of engagement” for participating insurers and offer consumers a menu of choices among different plans that have some standardization of features. The goal of a health insurance exchange is to shift the market from competition based on risk to competition based on price and quality.

What is a Public Insurance Exchange?

The Patient Protection and Affordable Care Act (PPACA) created “public” insurance exchanges. Under PPACA, each state must establish an insurance exchange by January 1, 2014. If a state does not establish an exchange, then the federal government will establish a federally facilitated exchange for that state. Exchanges are intended to help enhance competition in the health insurance market, improve choice of affordable health insurance and give small businesses purchasing power similar to that of large businesses.

The main functions of the public insurance exchange, as laid out in PPACA, include:

Certifying, recertifying and decertifying health plans offering coverage through the exchange, called qualified health plans (QHPs)

Assigning ratings to each plan offered through the exchange on the basis of relative quality and price

Providing consumer information on qualified health plans in a standardized format

Creating an electronic calculator to allow consumers to assess the cost of coverage after application of any advance premium tax credits and cost-sharing reductions

Operating an internet website and toll-free telephone hotline offering comparative information on qualified health plans and allowing consumers to apply for and purchase coverage if eligible

Determining eligibility for the exchange, tax credits and cost-sharing reductions for private insurance, and other public health coverage programs, and facilitating enrollment of eligible individuals in those programs

Determining exemption from requirements on individuals to carry health insurance, granting approvals to individuals relating to hardship or other exemptions

Establishing a Navigator program to assist consumers in making choices about their health care options and accessing their new health care coverage, including access to premium tax credits for some consumers

In addition to these basic functions, public insurance exchanges will have to implement outreach and education programs and comply with oversight and program integrity requirements.

The Department of Health and Human Services (HHS) has issued regulations on the establishment of public exchanges that provide a framework of minimum requirements for states establishing exchanges, for insurers wanting to offer QHPs through the exchanges, for determining individual eligibility and enrollment in a QHP under an exchange and for small employers wanting to enroll their employees in small market QHPs through a Small Business Health Options Program (SHOP).

A state-based exchange must be a governmental agency or nonprofit entity established by a state. States have some flexibility in their design. They may establish an exchange as a state agency or a nonprofit organization, and may choose to contract with an eligible entity to fulfill various functions of the exchange (insurers are not eligible to be contractors). The entire geographical region of a state must be covered by one or more exchanges, but states can choose to partner with the federal government, establish regional exchanges in collaboration with other states, or establish one or more subsidiary exchanges within a state.

HHS has also provided information on the state partnership model, which is intended to give states another option to tailor their exchange to accommodate local needs and market conditions and provide an opportunity for HHS and a state to work together to operate different functions of the exchange. According to HHS, the partnership model is also a way that states can transition to fully operating their own exchanges.

Although the exchanges will begin in 2014, HHS is required to determine whether each state’s exchange will be fully operational by January 1, 2014. This is important because exchanges are to start their initial open enrollment period on October 1, 2013. HHS may conditionally approve a state-based exchange upon demonstration that it is likely to be fully operational by the start of the October 1, 2013 open enrollment period. In states that don’t obtain HHS approval or in states that decide not to establish an exchange, a federally facilitated exchange (FFE) would be implemented by HHS for 2014.

In states without a state-based exchange, HHS will establish a FFE and perform all exchange functions including plan management functions (such as certifying, recertifying, and decertifying QHPs) and consumer-assistance functions (such as providing consumer assistance in determining individual eligibility for enrollment and insurance affordability programs, including advance payment of the premium tax credit and cost-sharing reductions). As noted above, a state may choose to establish a state partnership FFE which permits the state to administer plan management functions and/or consumer-assistance functions.

Who Can Participate in a Public Insurance Exchange?

Beginning in 2014, individuals may enroll in a plan through the exchange of the state where they reside. Only lawful residents may obtain coverage in an exchange. Unauthorized aliens will be prohibited from obtaining coverage through an exchange.

Beginning in 2014, small employers can offer coverage to their employees through a public exchange. For this purpose, a “small employer” is an employer that employed an average of at least one but not more than 100 employees on business days during the preceding calendar year, and employs at least one employee on the first day of the plan year. However, before 2016, a state will have the option to define “small employer” by substituting 50 for 100 in the standard definition.

Beginning in 2017, states may allow large employers to obtain coverage through an exchange. A “large employer” is an employer that employed an average of at least 101 employees on business days during the preceding calendar year, and employs at least one employee on the first day of the plan year.

What is a Private Insurance Exchange?

Private exchanges were actually in place prior to the enactment of PPACA (although they were not known as “exchanges” until after PPACA was enacted). Private exchanges are essentially marketplaces for insurance and other products. The private exchanges seen today generally sell health insurance to individuals in the individual health insurance market, employees of employers and retirees seeking Medicare supplemental coverage. Private exchanges differ from public exchanges in that they are not run by the government or an entity established by a government. Emerging private exchange models include multi-carrier exchanges offering individual and/or group health plans and single carrier exchanges offering group health plans.

The general purpose of private exchanges is to offer a consumer-friendly way to purchase health insurance through the use of creative and interactive technology. Private exchanges come in many different models and sizes and offer an array of choices in regards to benefits and costs. The specific choices available, as well as the costs, would be determined by the private exchange. General attributes of a private exchange include:

A consumer focused buying experience

Robust decision support tools intended to help consumers choose the plans that best meet their individual needs

Technology based “backbone”

A significant increase in plan options available to consumers

Customer service support

Greater employee ownership and responsibility over health care decisions

Reduced employer involvement, particularly in regards to administration

Personalized member experience

“Point and click” purchasing platform

Increased employer cost predictability and controllability (i.e., moving from a defined benefit to a defined contribution approach)

Who Can Participate in a Private Exchange?

Similar to public exchanges, both individuals and employers (on behalf of their employees) can participate in a private exchange. Specific offerings by the exchange (e.g., whether group or individual products) would be determined by the sponsor of the exchange. Private exchanges could be a resource for those individuals who are not eligible for the tax credits that some individuals may obtain through the public exchanges or for large employers who will not be eligible to participate (as employers) in the public exchanges.

How Can Employers Participate in a Private Exchange?

Employers will decide the extent of their participation in a private exchange. An employer could, for example, purchase health insurance through a private exchange and allow employees to choose among the options offered by the exchange. The employer could also choose to limit which options are available to its employees. Some employers may choose to move to a defined contribution approach of providing benefits by giving employees a specific dollar amount to purchase coverage through the exchange.

Will Participation in a Private Exchange Help an Employer Avoid Health Care Reform’s “Pay-Or-Play” Penalties?

Starting in 2014, large employers – those with 50 or more full-time employees (with part-time employees counted as fractions) – may incur an excise/penalty tax unless they meet standards for offering health coverage to their full-time employees. Details of the excise tax are beyond the scope of this employer guide, but it is important to know that an employer can entirely avoid the excise tax by offering minimum essential coverage to full-time employees and their dependents, provided that the coverage is both affordable and sufficiently valuable with respect to coverage of the employee. Even if an employer is not able to avoid the excise tax altogether, it can minimize the tax it might incur by offering minimum essential coverage to its full-time employees and their dependents even if that minimum essential coverage is neither affordable (employee’s required contributions for self-only coverage are not greater than 9.5% of income) nor sufficiently valuable (coverage has an actuarial value of 60% or greater).

Although additional guidance is needed, it appears that private exchange coverage could prevent the pay-or-play penalty from applying in whole or in part because an employer offering coverage through the private exchange could be viewed as offering the coverage purchased through the private exchange. The extent to which an employer could avoid the penalty would depend on (1) whether the private exchange coverage was minimum essential coverage offered to all, or substantially all (meaning that the employer offers coverage to all but 5% or, if greater, five of its full-time employees), full-time employees and their dependents and (2) whether the private exchange coverage offered to full-time employees was affordable and sufficiently valuable.

What is a Defined Contribution Approach to Providing Benefits?

Under a defined contribution strategy to providing health care benefits, the employer decides how much it will spend on health care coverage on a yearly basis and then makes that fixed contribution amount available to its employees to purchase coverage. Employees can then use those funds to choose the coverage that best fits their specific health care needs. Many private exchange models propose to use a health reimbursement arrangement (HRA) as the mechanism for such a defined contribution approach.

An HRA typically is an unfunded or notional account maintained by an employer that reimburses employees or former employees for substantiated medical care expenses incurred by the employee and the employee’s spouse, dependents and children who are under the age of 27 as of the end of the employee’s taxable year up to the employee’s HRA account balance. Any reimbursements paid from the HRA must come from employer funds; employees are not permitted to contribute, directly or indirectly, to the HRA. An HRA provides reimbursement up to a maximum dollar amount for a coverage period as set by the plan. Unlike a health flexible spending account (FSA) where all funds in the health FSA are subject to a use or lose rule or a health savings account (HSA) where all unused funds automatically roll over to following years, with an HRA it is the sponsor’s decision whether 100%, some portion, or none of the unused account balance will be rolled forward for use in future years or after the employee terminates employment or retires.

An HRA may reimburse only medical care expenses as defined in Internal Revenue Code §213(d). An HRA may also provide reimbursement for premiums for accident or health coverage for current employees, retirees, and COBRA qualified beneficiaries. Certain issues are raised in regards to using an HRA to pay for insurance premiums and it remains to be seen if the HRA funding will satisfy certain requirements under the health care reform law, including the employer pay-or-play mandate and the prohibition on annual dollar limits.

Employer Pay-or-Play Mandate

Available guidance does not specifically address how an HRA can be used to comply with the employer pay-or-play mandate. If an employer gives its employees a fixed contribution through an HRA (e.g., that could be used to pay for premiums for coverage through an exchange), the employer contributions could be viewed as “offering minimum essential coverage” for purposes of the employer-pay-or-play mandate discussed above. Assuming that the HRA qualifies as employer-offered coverage, for the employer to completely avoid the pay or play penalty, the coverage must be affordable and sufficiently valuable. Additional guidance is needed to make this determination.

In some cases, the employer’s involvement with private exchange coverage may result in sponsorship for ERISA purposes and/or offering coverage for play-or-pay purposes. It is important to note that the analysis of those issues would depend on the specific private insurance exchange arrangement and the employer’s involvement with it. Therefore, it is not possible to say with certainty whether any particular private insurance exchange would result in an employer sponsorship or offering of the coverage purchased on that exchange.

Annual Dollar Limits

Effective for plan years beginning on or after January 1, 2014, group health plans may not include annual limits on the dollar amount of essential health benefits provided by the plan for any individual. For plan years beginning before January 1, 2014, however, annual dollar limits remain permissible if they are no lower than specified amounts (e.g., $2 million for plan years beginning on or after September 23, 2012 but before January 1, 2014). These very high annual limits are not relevant for most HRAs, however.

There are several exceptions that relieve certain HRAs from the annual dollar limit restrictions. For example, an HRA is exempt if the maximum amount of expenses that the HRA may reasonably be expected to reimburse is less than five times the value of the HRA coverage (the value of coverage often is said to be roughly equivalent to the COBRA premium for the coverage (less the 2% add-on)). In addition, HRAs that are integrated with other coverage as part of a group health plan will not violate the annual limit rules so long as the other coverage on its own would comply. Unfortunately, available guidance does not explain what is needed to make an HRA integrated. In regards to the issue of HRAs and integration, the agencies charged with implementing the health care reform law (the Departments of Labor, Treasury and Health and Human Services) recently indicated that that they intend to issue guidance that provides:

That an HRA used to purchase coverage on the individual market will not be considered to be integrated with that individual market coverage. An employer-sponsored HRA cannot be integrated with individual market coverage or with an employer plan that provides coverage through individual policies. Therefore, the HRA would not comply with the rules on lifetime and annual dollar limits.

That an employer-sponsored HRA may be treated as integrated with other coverage only if the employee receiving the HRA is actually enrolled in that coverage.

It would appear from this guidance that stand-alone HRAs that do not comply with the annual dollar limit requirements and do not fit into one of the available exemptions (e.g., those for retiree-only plans or excepted benefits) will no longer be permitted.

Some stand-alone HRAs may currently be receiving a waiver from the annual dollar limit requirement. HRAs that are not otherwise exempt from the annual limit restrictions (and which existed on September 23, 2010) could obtain permission to have otherwise non-compliant annual dollar limits during plan years starting before January 1, 2014 under an HHS waiver program. Many HRAs requested and received waivers under this program, and HHS issued guidance allowing the waiver to apply to many HRAs even without them applying for it. Additional information about HRAs can be found on Willis Essentials.


In 2014, taxpayers with household incomes between 100% and 400% of the federal poverty level will be eligible for premium assistance for coverage purchased through the public exchanges for themselves and members of their family who are not eligible for other health care coverage. Currently, the premium assistance is not available for coverage purchased through a private exchange.

Is Coverage Offered Through a Private Exchange Subject to Erisa?

ERISA applies to employer-sponsored welfare benefit plans. An ERISA “welfare benefit plan” (also called an “employee welfare benefit plan”) is any plan, fund, or program established or maintained by an employer (or employee organization) for the purpose of providing medical and certain other types of benefits for its participants (employees, former employees and certain others) or their beneficiaries, through the purchase of insurance or otherwise. Coverage purchased through a private exchange is clearly the type of benefit that may be subject to ERISA. The question for most private exchange arrangements is whether that coverage is provided under a plan that is established or maintained by an employer.

The Department of Labor (DOL) has established for an exemption from ERISA for certain “voluntary” or “employee-pay-all” programs, setting out four conditions for these programs to be deemed not employer-sponsored:

No contributions are made by an employer or employee organization

Participation in the program is completely voluntary for employees or members

The sole functions of the employer or employee organization with respect to the program are, without endorsing the program, to permit the insurer to publicize the program to employees or members, to collect premiums through payroll deductions or dues checkoffs, and to remit them to the insurer

The employer or employee organization receives no consideration in the form of cash or otherwise in connection with the program, other than reasonable compensation, excluding any profit, for administrative services actually rendered in connection with payroll deductions or dues checkoffs

Many “employee-pay-all” arrangements fail to qualify for this exemption because the employer directly or indirectly “endorses” the program as its own. It is important to note that even individual products can be subject to ERISA if they are paid for (even through the use of an HRA) or endorsed by the employer.

Several formal opinions have been published by the DOL addressing the issue of when an employer or employee organization has “endorsed” a program in a way that makes it a welfare benefit plan that is subject to ERISA. The exemption depends in large part on whether the insurance company or an enrollment firm offers the plan, rather than the employer. The DOL’s position is that the level of involvement by the employer or the employee organization is “the key for determining whether a plan is exempted under the regulations.” For those wishing to taken advantage of this exemption, the participation of the employer or employee organization should be limited to the duties specified in the regulation, none of which involve the exercise of discretion over program administration. An employer hoping to rely on this exemption should also be careful not to create the impression that the benefit is part of its benefit package. For example, the employer would want to avoid including information about it in enrollment materials or encouraging employees to enroll. In various opinion letters, the DOL has described the following employer activities as exceeding the limited involvement allowed under the terms of this exemption:

Assistance in the preparation of claims forms

Receipt of the contract in the employer’s name

Employer’s choosing of the insurance company and the coverage

Negotiating with the insurer

Sending premium notices and collecting premiums as directed by the insurer and transmitting premiums to the insurer other than through a payroll deduction or dues checkoff


Sending descriptive literature under the name of the employer or employee organization

Permitting payment of premiums on a pre-tax basis through the employer’s Section 125 plan

Some court cases have approved of some of these activities, determining that a plan is still considered “voluntary” and exempt from ERISA even if the employer carries out one or more of them. To avoid confusion on the part of participants, many employers specifically disclaim status as an ERISA plan. However, plan sponsors should be mindful that merely disclaiming ERISA status may not protect the benefit from ERISA requirements if the facts and circumstances indicate that the benefit is, in fact, subject to ERISA.

Can Coverage Through a Private Exchange be Paid on a Pre-Tax Basis?

Available guidance provides that coverage offered through a public exchange generally will not constitute a qualified benefit under Internal Revenue Code §125 and therefore cannot be offered under a cafeteria plan. However, there is an exception for exchange-eligible employers that purchase group coverage through an exchange and offer their employees the opportunity to enroll in that plan. Under these circumstances, employees may pay for such coverage with pre-tax dollars under the employer’s cafeteria plan.

Current guidance does not preclude pre-tax payments for coverage purchased through the private exchange. Such private exchange coverage can be offered as a cafeteria plan benefit. As noted above, however, allowing pre-tax payments increases the likelihood that the coverage will be deemed an ERISA plan.

Disclaimer: The information provided on this webpage is for informational purposes only. It is not and is not intended to be tax or legal advice. Consult with your own tax advisor and/or attorney.