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If policy makers could come up with a way to enable small firms to buy health insurance for their employees at the same frequency as large firms, this would go a long way to resolving the uninsured problem. But how to make health insurance affordable to firms with fewer than 10 workers – where the risk pools are smaller and employee compensation often lower – remains a great challenge. How the next President will deal with that issue could make a difference to the majority of small firms who do not offer health benefits and to their uninsured employees.

Kosali Ilayperuma Simon, Ph.D., Associate Professor in the Department of Policy Analysis and Management, Cornell University

  Kosali Simon, a Cornell University Associate Professor in the Department of Policy Analysis and Management, studies the impact of regulatory programs designed to make health insurance more available for vulnerable populations, including workers in small firms. Simon, who also is a Faculty Research Fellow of the National Bureau of Economic Research and a research associate of the Census Bureau, investigates the determinants of health and health care use. She is the 2007 recipient of the John D. Thompson Prize for Young Investigators and has published a variety of research papers. Simon talked to ERIU about the problems with and myths about the small group market, as well as highlighting policies likely and unlikely to improve coverage rates for workers employed by small firms.


What are the biggest reasons that small firms don’t offer health insurance to their workers at the rates that large firms do?

SIMON: There are a couple of major reasons, including the size of the purchasing group. Small firms face higher administrative costs and lower economies of scale because of their smaller size. Health insurers also suspect more of what is known as “adverse selection” among smaller firms, as compared to larger firms. That is, they fear that among smaller firms (far fewer of whom seek health insurance contracts), it is more likely that the employees of those seeking insurance are sicker than the average worker at large firms seeking health insurance.  Therefore, smaller firms face higher prices for the same coverage as larger firms. Another reason why small firms do not offer health insurance as often as large firms is related to the characteristics of small firm workers. They tend to have a lower demand for health insurance, mainly because they tend to be lower-skilled and receive a smaller total compensation package.

What percentage of workers in small firms is covered and how does that compare to larger firms? how does the coverage itself compare?

SIMON: The Employee Benefits Research Institute (EBRI)’s analysis of data from the Current Population Survey (CPS) shows that in 2006 more than 35 percent of workers in private-sector firms with fewer than 10 employees were uninsured, compared with 13.0 percent of workers in private-sector firms with 1,000 or more employees. But one needs to also consider the source of the health insurance coverage. Among workers in small firms, 27 percent are covered through their own employer, while 65 percent of employees are covered through their own employer in large firms.

In terms of health insurance policies themselves, the total cost of the policy purchased by a small versus a large firm does not differ substantially (e.g. $4,356 per year for the average single policy bought by a small firm versus $3,954 per year for the average single policy bought by a large firm; for family health insurance the premium at larger firms is actually larger than at a small firm, at $10,673 versus $10,749), however small firms buy policies with deductibles that are almost twice what they are in large firms. There is much less of a difference in office visit copays. Small firm workers also tend to be offered fewer plans from which to choose, are more likely to be covered under a single policy than a family policy, and are less likely to be offered retiree health insurance.

It might be surprising that when you look at what employees pay towards the premium for insurance policies offered through a small firm, it actually looks better than in a large firm. In a small firm, you are much more likely to have zero premium contribution. It’s about 20 percentage points more likely that you are going to have employees not contributing anything to coverage in a firm with fewer than 10 employees than in a large firm. These data are from the Medical Expenditure Panel Survey Insurance Component. There is a very good reason for this.  When a small firm is seeking health insurance, it needs to convince the insurer that the policy is not just for a handful of sick workers. If a small firm goes to an insurer with only two out of ten workers buying health insurance, the insurer will be concerned about adverse selection more than if nine out of ten workers sought the plan. Thus small firms have a strong incentive to offer a policy guaranteeing a high take-up rate and this is accomplished by reducing the employee contribution.    

What percentage of workers who are employed at small firms, though, have access to health insurance either through a spouse or public program?

SIMON: Workers in small firms are more likely to have dependent coverage as their source of coverage. The EBRI report for 2006 shows that among workers aged 18-64 years, in a firm with fewer than 10 employees, 48.6% of them have insurance that is employment based; 27% in own name and 22% from dependent coverage. Among firms with 1,000 or more employees, almost 80% have insurance that is employment based, with 65% being in own name and 14.4% being dependent coverage.

Why is it that state small group market reforms and federal HIPAA have never really brought relief to the insurance plight of small firms or their workers? 

SIMON: It’s quite likely that the key issue plaguing small firms is the inability to afford high premiums. But these small-group market reforms weren’t trying to lower premiums; they were focused on ensuring equality of access (and sometimes of premiums too through the state laws) regardless of the health profile of one small firm vs. another small firm. The reforms say that regardless of the health status of your workers, you would be able to buy health insurance, and that you wouldn’t be turned down if you were in an industry with high accident rates or that attracted demographic groups that had high health care costs. But, that guarantee had to come at a price. So, if anything, premiums are going to go up and not down since insurers are not able to use their former methods of selecting customers and targeting prices.

What have been the most successful attempts to increase the number of small employers offering coverage to their workers?

SIMON: It’s hard to think of any policy intervention that has been successful to date. There are cases where things didn’t work, for example, subsidies and small group reform were not as effective as expected. 

So you have the biggest source of uninsurance within the employer landscape coming from small employers, and yet there is nothing people can really point to as successful attempts to change that?

SIMON: It does seem strange. We assume that if small firms can get the equivalent health insurance policy that a large firm gets at prices that large firms pay, then that should solve their disadvantage. This would not happen in practice as there are other differences (worker characteristics and compensation) than just prices for low coverage by small firms. But it’s frustrating that we can’t point to any policies that have worked for small firms.  It could be that prices need to be even lower and there have not been any policies designed to lower insurance prices by that much. One way to get premium prices lower is to pare down the benefit package.  But even though some state laws allow small firms that have not previously offered health insurance to buy stripped down versions of health plans, you haven’t seen small firms flocking to them historically. And, while high-deductible health plans might provide an opportunity for small firms to provide workers with more affordable protection against large and unpredictable health care costs, right now it seems to be that larger firms rather than smaller firms are showing interest in these policies. 

So what incremental steps can policy makers take to improve health insurance offer rates and take-up rates in small firms?

SIMON: Policy changes that might hold some promise revolve around lessening adverse selection concerns through the use of state high risk pools (mechanisms to insure the sickest workers outside of the regular commercial insurance market), and making small firms look like large firms through “pooled” purchasing arrangements.

The idea of establishing pools has been given a lot of thought lately because of states considering plans like the Massachusetts Connector to help small employers buy health insurance. To be efficient, the pool should be as large as possible and have binding features, such as long-term contractual requirements. Massachusetts has a mandate and a pooling mechanism, so they are not afraid of people pulling out.

Without a mandate, some sort of a long-term contractual commitment will help.    Promoting stable legal arrangements to have small employers buy health insurance in pools is a strategy that should make them look like large firms in health insurance purchasing. Pooled purchasing of supplies is done in other industries where small firms band together, such as in the concrete industry. However, if it were simply a matter of size, the private market in theory would have solved this problem using pooling arrangements. This hasn’t happened, possibly because of adverse selection.

One of the problems with getting a voluntary pooling mechanism is the concern faced by a small firm with healthy employees about being the first to join a pool with a small firm with several sicker employees. They will need assurance the pool will be large and stable enough and that the other small firms will not drop out once their workers become healthy again. Whether because of legal reasons or unenforceable contracts, these arrangements appear not to be widely used right now. I am hopeful that policy makers implement changes and incentives for sustainable long-term pooling arrangements in the future. 

Do small firms take advantage of the tax benefits that large firms do?

SIMON: Not many small firms that offer health insurance take advantage of tax options that allow for an employee contribution to the premium to be made pre-tax. It's hard to know whether this is because of the lower incidence of employee premium cost sharing in small firms in the first place. Small firms also are much less likely to have flexible spending accounts, so whatever the worker is contributing to out-of-pocket costs is less likely to be tax preferred, both in terms of co-premiums and service co-payments.

What could policy makers do if they wanted to more boldly help stabilize premiums and make them more affordable overall?

SIMON: Subsidies can help, but the question remains where should the subsidies be targeted (e.g., all small firms, just those who are uninsured in small firms, all low-wage workers regardless of firm size, or strictly by family income rather than individual worker or firm characteristics). Meanwhile, an idea that Professor Katherine Swartz has talked about is reinsurance and removing the risk of the highest cost so that insurers don’t have to fear that they will get the worst of the possible scenarios. An example of where reinsurance is currently being practiced is Medicare Part D.  

We should be realistic about what can be done for small firms given the types of industries they represent and the characteristics of their workers. Even after adding small firms together, they may not look like a large firm. 

It appears some small employers who were offering coverage are now just giving their workers a set amount of dollars to purchase coverage on their own in the individual market. How efficient or less efficient is that?

SIMON: This would only worsen the size disadvantage suffered by small-firm workers if they tried to purchase health insurance on their own rather than in groups of 2-10 workers. There is also a tax disadvantage as individuals are not able to deduct health insurance costs the way that (even small) businesses can. 

What about bare-boned policies? Do they help?

SIMON: Any kind of policy that allows small firms to offer something that is close to catastrophic coverage should be a good thing because it is those kinds of costs that society is most interested in insuring against. But as mentioned already, prior policy attempts to offer bare bones policies to small firms have not shown a lot of promise.

What about the notion of small employers buying into FEHBP or Medicare as some huge group?

SIMON: Buy-ins along these lines are great ideas, particularly with FEHBP, which has a stable, healthy group of federal employees who are getting good options because a large group negotiated for them and they are seen by insurers as a desirable group to insure. However, they may need to offer something like subsidies to those already in the pool to reassure them that they will not face increased rates if small firms join their pool.
What about association health plans (AHP)? Do they make sense?

SIMON: Under an AHP, small businesses can band together through trade or professional organizations formed for reasons other than insurance (proposals also suggest this could be done through other community-based organizations). These plans would not be subject to the same state or federal tax laws that apply to employer group plans that are sold commercially. The bottom line appears to be that it’s not as simple, legally, to make small firms look like large firms because the entities that create the pool aren’t as altruistic as one firm’s human resources department. So that may be an argument for allowing more state laws on consumer protection to apply and to allow participating employers to deduct the amounts employees pay.  

The idea of having small firms enjoy the same bargaining power as large firms certainly makes sense. However, there is a lot of opposition to proposed AHP legislation that has been supported by the current administration because of the possibility that consumers won’t get the same protections they receive under state regulations. The reason for this is that AHP would (under current proposals) be exempt from state laws the same way that large firms that self-insure are exempt.

Do policies need to promote or increase portability of health insurance between jobs beyond what HIPAA has achieved? 

SIMON: HIPAA limits the waiting periods that insurance policies can apply to already existing ailments when moving from one job with health insurance to another. But it’s very difficult for workers to get health insurance while unemployed between jobs. The unemployment system compensates partially for lost wages, but offers nothing for lost health insurance. (An exception is the Trade Adjustment Act, which offered limited subsidies for health insurance for displaced workers.) Even if you are allowed to buy into an employer plan through COBRA, the evidence shows take-up is very low; not surprising since the worker must then pay the entire premium.

Would it be more efficient to target individuals who are without coverage, who happen to work for small firms, rather than to try to get the small employer to offer coverage?

SIMON: Possibly—if many in small firms are getting health insurance from other employers through a spouse and that system works for them, perhaps policy should attempt to get small firm employees who are uninsured into a pool that is outside an employer arrangement (but still enjoys economies of size and the same tax advantage as employer groups). In theory, a sustainable and enforceable pooling arrangement for small firms should solve this. The remainder of the uninsurance problem is one of equity, if the reason for lower coverage in small firms is due to low skills and incomes.


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Funded by The Robert Wood Johnson Foundation, ERIU is a five-year program shedding new light on the causes and consequences of lack of coverage, and the crucial role that health insurance plays in shaping the U.S. labor market.