Written by John Goodman
Would employers risk rate employees on their employer health insurance plans if they could? Why don’t they impose a mandate on employees? These questions are asked by Austin Frakt. (See here and here.) In asking them, he is inviting us to compare employer insurance pools with markets such as those envisioned in the ObamaCare health insurance exchanges.
Let’s take the second question first. It goes to the question of why employer pooling works.
We are told that ObamaCare needs a mandate in order to prevent people from gaming the system. Without the mandate, people who are healthy would remain uninsured until they had a health problem. Then they would enroll and get their medical bills paid. But if that were possible, only the sick would insure ― making premiums inordinately high and possibly leading to a “death spiral.”
Yet employers don’t require employees to enroll in their health insurance plans. So why don’t they experience death spirals?
Potentially, they could face something similar. The reason: employers have exactly the same problems that the individual market has. Here is how they solve it.
Commercial insurers generally won’t sell insurance to an employer unless the employer agrees to:
Pay a substantial portion of the premium (usually 50% is required, but the average is around 75%).
Restrict enrollment to a certain date or to a qualifying event, such as a marriage or the birth of a child.
The first restriction means that employees can buy insurance for 25 cents on the dollar. This makes insurance attractive, even to people who don’t plan on any medical expenses in the near future. The second restriction means that even if people try to game the system, they have to wait up to a year before they can enroll after they experience a serious medical problem. This is the employer’s version of an open enrollment period.
Alert readers may wonder why employers aren’t paying even more of the premium. Answer below the fold.
If employers can pay premiums with pretax dollars while employees generally pay their share after-tax doesn’t it make sense for the employer to pay the entire amount? The problem is that employers have no way of knowing how valuable this benefit is to each employee.
Suppose an employee pays 25% of the premium after tax. Given a 40% marginal tax rate (combined federal and state income taxes and payroll taxes), the insurance would have been 10% cheaper if the employer had made the full payment instead. If the employee pays 50% of the premium, a 20% discount is left on the table.
On the other hand, about 20% of employees turn down their employer’s offer and among young employees it’s 30%. That means the insurance is not worth what it costs, even though the employee is paying half or less of the real cost. In competing for labor, employers follow a better strategy (especially for younger workers) if they pay less of the premium and pay higher wages instead.
[Aside: In saying this I am ignoring the fact that most employers mis-price the employee's share of the premium. Although small employers may age rate, large employers typically charge employees the same premium regardless of age. If employees are charged 25% of the premium, this means that a young worker's share is closer to 50% of the real cost and an older worker's share is closer to 10%. And if we remember that young healthy workers could undergo medical underwriting and get a substantial discount in the individual market, the premium their employer asks them to pay may be substantially more than half of the real cost.]
Why don’t employers risk rate? Medical underwriting is illegal for employers under HIPPA. But employers weren’t doing it even when it was legal. Right? Not quite.
Let’s do this in two stages.
First, why don’t employers re-rate employees once a year, based on their health status, the way small groups are re-rated? The answer is that the alternative to employer provision is individually purchased insurance. And in the individual market, no re-rating and guaranteed renewability has always been the norm. If employers are going to complete for labor based partly on their ability to purchase insurance pre-tax, it needs to be the kind of insurance (with the same protections) that workers can purchase on their own.
Second, why don’t employers risk rate new employees? I suspect part of the explanation is the economics of signaling. The employer is trying to attract labor that is often coming from some other place where the insurance does not involve further risk rating (another employer or an individually purchased policy). If the employer is going to do it once, how does the prospective employee know the employer won’t do it again? For that matter, if the employer risk rates new hirers, how do the current employees know they won’t be risk rated at some point in the future?
That said, employers have placed pre-existing condition waiting periods on new hires in the past. The current law (HIPAA) allows pre-existing condition exclusions of 12 months or 18 for late hires.
There are two more things employers are doing that I wrote about in Priceless:
The health insurance they offer employees is designed to appeal to the healthy at the expense of the sick.
Companies are developing cultures of “healthy living,” which tend to appeal to prospective employees who already lead healthy lifestyles and repel those who don’t.
Almost all the insurance products being sold to employers these days have first dollar coverage (or small co-payments) for doctor visits and preventive care ― and this was true even before ObamaCare required some of this. At the same time, these plans can cost an employee $10,000 or more in case of a hospital visit. (The new law restricts the total.)
The first item is perverse. But it duplicates what is happening in the health insurance exchanges. As for the second item, I suspect we are going to see more of that in the exchanges as well.
This reflects the fact that the employer health insurance functions in a way like one big exchange. Think of employers as health insurers and think of your premium as the work you have to do for the employer in order to get the insurance. All the employers are required to guarantee issue and community rate (at least modified). So like the health plans in the (ObamaCare) exchanges, employers have strong incentives to attract the healthy and avoid the sick. After enrollment, they have strong incentives to over-provide to the healthy and under-provide to the sick. (See our previous analysis here.)
This blog is one of the very few places on the Internet ― maybe the only place ― where you can find out about these perverse incentives and the reasons why they arise.
John C. Goodman is President of the National Center for Policy Analysis, Research Fellow at the Independent Institute, and author of the book Priceless: Curing the Healthcare Crisis.
The Wall Street Journal and the National Journal, among other media, have called him the "Father of Health Savings Accounts." Dr. Goodman's health policy blog is the premier right-of-center health care blog on the Internet.
It is the only place where pro-free enterprise, private sector solutions to health care problems are routinely examined and debated by top health policy experts across the ideological spectrum.