Monday, January 16, 2006
To Government and Employers: How to reform health insurance
The recent Medicare prescription drug debacle should cement in the public's collective mind that, despite political rhetoric, the Federal government is incapable of managing health insurance on a national level.
The states, burdened with ever higher costs from Federal Medicaid mandates, are now flexing their legislative muscles. Maryland last week passed legislation that requires large corporations in the state to spend a minimum of 8% of their payrolls on employee health insurance, or pay the difference into a state Medicaid fund.
Businesses are worried, and they should be. Although the law effectively applies only to Wal-Mart, it is a harbinger of more government meddling in corporate spending. The Maryland Chamber of Commerce is reportedly suing to block the law.
But businesses share the blame for the unnatural tying of health insurance to employment. In the absence of artificial frictions, there is no compelling reason why employers should be the front-line providers of health insurance. Indeed, it's easy to argue that a person's health care should not be tied to their employment: it reduces labor mobility by locking employees into sub-optimal jobs; it puts employees and their families at risk if they lose their employment; and it hides the true cost of health care from individuals, leading to inefficiency and waste.
Businesses don't offer health insurance out of pure altruism. In a publication entitled "Health Insurance: A Small Business Guide," the New York State Insurance Department lists the following reasons why small businesses offer health insurance:
to keep employees healthy and productive to help attract and retain employees because employees "need it" because employees "demand it" and because the owners/managers want the coverage for themselves and
their families.
The first point is hard to support from experience. If businesses were truly concerned about healthy employees, we would see more companies subsidizing nutritious meals and fitness initiatives, which are far cheaper and far more effective than insurance at maintaining a healthy workforce. Moreover, if businesses wanted more preventive health care, they would pressure the insurers to provide it. As it stands, aside from regular checkups, health insurance policies by and large are designed to treat illness, not prevent it.
The other four points are all related to the institutional asymmetries that exist between private individuals and businesses. Because individual health insurance is typically more expensive than so-called "group" policies, businesses have a cost advantage over the individual family. In addition, companies can deduct the cost of insurance from their taxes as a business expense, whereas an individual is severely limited in this regard by the tax law. (Until a few years ago, even the self-employed were hamstrung by the tax law.) Businesses use this pricing "arbitrage" to their advantage, offering tax-free insurance in lieu of taxable cash.
It is, in theory, a win-win situation. However, the employee is dependent on the employer for health insurance, making it more difficult for the employee to quit and search for a higher paying job. Laws such as COBRA offer some safety net, but COBRA applies only to companies with 20 or more employees (some states have expanded coverage), premiums can be high (102% of group rate), and the replacement coverage is often of low quality. Businesses certainly use insurance to "retain" employees, but more through coercion than choice.
Insurance companies share responsibility for the sad state of health coverage in the U.S. New York's health insurance guide, in a section called "What Affects Coverage?" goes on to say:
This statement echoes similar comments from the insurance industry. Insurers argue that, compared to individuals and small groups, large groups provide better risk pooling, more predictable loss experience, and lower marketing and support costs.
The argument is specious. From an actuarial standpoint, risk pooling occurs at the insurer level, not the group level. Whether an insurer covers one group of 1,000 employees or 1,000 groups of sole proprietors, the experience is about the same. And the dividing lines are completely arbitrary. In New York state, a sole proprietor can expect to pay 20% more for insurance than if she had a single employee. Moreover, the sole proprietor, if she purchased her insurance as an individual, would expect to pay substantially more.
A comparison to auto insurance shows that the insurance companies' argument for employer-sponsored health insurance is overstated. If risk pooling were as effective as claimed at the group level, and insuring large groups offered significant (20%+) cost reductions in marketing and customer support, surely insurance companies would be working with large employers to offer auto insurance at vastly discounted rates. After all, 45 states require auto insurance, and nearly every family in the U.S. owns a car. However, employer sponsored auto insurance is rare, and, while some companies offer group discounts, the vast majority of auto insurance policies are purchased by individuals at regular rates.
While there are likely some cost savings for insurers doing business at the group level, a more credible explanation for the tiered premium structure is that it mirrors the structure of political and market power. Large employers wield formidable influence over politicians and insurers. Indeed, Wal-Mart has enough lobbyists dedicated to the health-care bill in Maryland to warrant a "chief lobbyist." The insurance industry is one of the most powerful lobbying forces in the nation. Large employers and the insurers can and do skew Federal tax law and state insurance law in their favor. Small businesses and individuals typically have far less power and tend to be fragmented (unions and special interest groups such as the AARP notwithstanding).
That said, our short list of recommended insurance reforms include:
Level the playing field to ensure that individuals and the self employed have the same tax advantages when it comes to health insurance as do large corporations. Increase competition among insurers by eliminating state-sanctioned price fixing and discriminatory pricing tiers. Eliminate laws that hinder health insurance cooperatives. Presently, trade or civic groups can offer insurance, but only as a secondary function. Allowing health-insurance cooperatives to exist for that sole purpose would provide portable health insurance, while addressing insurers' concerns about risk pooling and servicing costs. Once the above are implemented, mandate health insurance coverage, with some conditions. Although this increases government involvement in some respects, it is not without precedent (e.g., mandatory auto insurance). It beneficially increases the pool of insureds, exposes the hidden costs from treating the uninsured and fills in the gaps in Medicaid. Families who cannot afford private insurance must have access to a state sponsored plan with means-based premiums. New York State, for example, has a several programs, including Healthy NY, Child Health Plus and Family Health Plus, that provide insurance for low-income individuals with income-based premiums.
Under these reforms, businesses could continue to offer discounted insurance as a perquisite, but would bear no responsibility for insuring their employees. Greater competition among insurers and buying power through insurance cooperatives would provide individuals and families with portable insurance at group rates. Tax-deductible premiums would reduce costs further and remove a disincentive to purchasing private health insurance. —GAHjr
The states, burdened with ever higher costs from Federal Medicaid mandates, are now flexing their legislative muscles. Maryland last week passed legislation that requires large corporations in the state to spend a minimum of 8% of their payrolls on employee health insurance, or pay the difference into a state Medicaid fund.
Businesses are worried, and they should be. Although the law effectively applies only to Wal-Mart, it is a harbinger of more government meddling in corporate spending. The Maryland Chamber of Commerce is reportedly suing to block the law.
But businesses share the blame for the unnatural tying of health insurance to employment. In the absence of artificial frictions, there is no compelling reason why employers should be the front-line providers of health insurance. Indeed, it's easy to argue that a person's health care should not be tied to their employment: it reduces labor mobility by locking employees into sub-optimal jobs; it puts employees and their families at risk if they lose their employment; and it hides the true cost of health care from individuals, leading to inefficiency and waste.
Businesses don't offer health insurance out of pure altruism. In a publication entitled "Health Insurance: A Small Business Guide," the New York State Insurance Department lists the following reasons why small businesses offer health insurance:
their families.
The first point is hard to support from experience. If businesses were truly concerned about healthy employees, we would see more companies subsidizing nutritious meals and fitness initiatives, which are far cheaper and far more effective than insurance at maintaining a healthy workforce. Moreover, if businesses wanted more preventive health care, they would pressure the insurers to provide it. As it stands, aside from regular checkups, health insurance policies by and large are designed to treat illness, not prevent it.
The other four points are all related to the institutional asymmetries that exist between private individuals and businesses. Because individual health insurance is typically more expensive than so-called "group" policies, businesses have a cost advantage over the individual family. In addition, companies can deduct the cost of insurance from their taxes as a business expense, whereas an individual is severely limited in this regard by the tax law. (Until a few years ago, even the self-employed were hamstrung by the tax law.) Businesses use this pricing "arbitrage" to their advantage, offering tax-free insurance in lieu of taxable cash.
It is, in theory, a win-win situation. However, the employee is dependent on the employer for health insurance, making it more difficult for the employee to quit and search for a higher paying job. Laws such as COBRA offer some safety net, but COBRA applies only to companies with 20 or more employees (some states have expanded coverage), premiums can be high (102% of group rate), and the replacement coverage is often of low quality. Businesses certainly use insurance to "retain" employees, but more through coercion than choice.
Insurance companies share responsibility for the sad state of health coverage in the U.S. New York's health insurance guide, in a section called "What Affects Coverage?" goes on to say:
Small-business owners say the high cost of premiums heads the list of reasons why they do not provide health insurance. Often small businesses have a difficult time getting the right help in understanding the insurance market. They may not receive satisfactory assistance from insurance representatives and consultants. Small businesses may not seem like ideal clients for insurers selling group coverage. The costs of marketing, installation and maintenance are relatively high. There is also a greater relative risk of "adverse experience" when fewer individuals are being covered as part of a group. In any given year, only a few individuals in a group of thousands are likely to be frequent users of health services. They may not always be the same individuals, but the proportion tends to remain stable and predictable. This is an example of the pooling principle that underlies insurance: many individuals pay premiums to cover the claims generated by a few. In a small group, i.e. one that is comprised of between two to 50 employees or members, not including spouses and dependents, experience is likely to be more erratic.
This statement echoes similar comments from the insurance industry. Insurers argue that, compared to individuals and small groups, large groups provide better risk pooling, more predictable loss experience, and lower marketing and support costs.
The argument is specious. From an actuarial standpoint, risk pooling occurs at the insurer level, not the group level. Whether an insurer covers one group of 1,000 employees or 1,000 groups of sole proprietors, the experience is about the same. And the dividing lines are completely arbitrary. In New York state, a sole proprietor can expect to pay 20% more for insurance than if she had a single employee. Moreover, the sole proprietor, if she purchased her insurance as an individual, would expect to pay substantially more.
A comparison to auto insurance shows that the insurance companies' argument for employer-sponsored health insurance is overstated. If risk pooling were as effective as claimed at the group level, and insuring large groups offered significant (20%+) cost reductions in marketing and customer support, surely insurance companies would be working with large employers to offer auto insurance at vastly discounted rates. After all, 45 states require auto insurance, and nearly every family in the U.S. owns a car. However, employer sponsored auto insurance is rare, and, while some companies offer group discounts, the vast majority of auto insurance policies are purchased by individuals at regular rates.
While there are likely some cost savings for insurers doing business at the group level, a more credible explanation for the tiered premium structure is that it mirrors the structure of political and market power. Large employers wield formidable influence over politicians and insurers. Indeed, Wal-Mart has enough lobbyists dedicated to the health-care bill in Maryland to warrant a "chief lobbyist." The insurance industry is one of the most powerful lobbying forces in the nation. Large employers and the insurers can and do skew Federal tax law and state insurance law in their favor. Small businesses and individuals typically have far less power and tend to be fragmented (unions and special interest groups such as the AARP notwithstanding).
That said, our short list of recommended insurance reforms include:
Under these reforms, businesses could continue to offer discounted insurance as a perquisite, but would bear no responsibility for insuring their employees. Greater competition among insurers and buying power through insurance cooperatives would provide individuals and families with portable insurance at group rates. Tax-deductible premiums would reduce costs further and remove a disincentive to purchasing private health insurance. —GAHjr
