Thursday, January 03, 2008

Future of Health Insurance Benefits?

Why the Present State May Be Unstable

I feel like I can see fault lines that could lead to the collapse of the current American system of employer-provided, group-plan health insurance. The way it works right now, employers typically extend coverage to all qualified employees, as a group. By getting hired and meeting the qualifications ( e.g., full-time), you are automatically eligible for group coverage, without regard to your personal health fundamentals--your desirability as an insurance risk. Because you are part of a group, your risk is blended into that of the group, and the annual claims experience of your group is used to re-adjust the rates each year.

This is unlike other forms of insurance. In other forms of insurance, your risk profile is considered as part of the underwriting decision as whether you are given insurance, and at what rate. Viewed from a social-good, shared risk perspective, this arrangement--whereby a less-healthy person, if they are well enough to get a job with benefits, effectively gets the more-healthy people to share the cost burden--may well be viewed as a good thing. However, when viewed from a pure, economic self-interest perspective, I wonder if it is about to become unstable?
The key thing to know is that medically under-written insurance (e.g., policies purchased by individuals) is typically considerably cheaper than non-medically underwritten, group insurance (the policies purchased by employers). The reason for this is simple--in medically under-written insurance, the high-risk 20% or so of applicants will either be denied, or "up-rated" (charged a higher rate, to account for higher-risk). Assuming some form of an "80-20 rule" applies, by excluding the 20% most undesirable applicants, a huge chunk of the total risk has been removed. Hence, lower rates for the remaining 80% of healthy applicants.
Group vs Individual Plans

For a long time, since World War II, a job "with benefits" was the litmus test for whether a job was a good, career position. Even lower-paid white-collar employees had health benefits as part of their jobs, as did most better-paid union jobs. Few people were in the market for individual health insurance, so it was not marketed heavily, and tended to be expensive, even though it was medically under-written, since the under-writers tended to assume that someone motivated enough to buy their own health insurance might have some expensive condition lurking in their health history.
More recently, however, for various reasons, there has been a growing market for individual health insurance. Now that market has truly come of age, and is being served both in terms of marketing, and pricing. So the large majority of employees who have company-provided benefits would nevertheless be better off if they could receive a credit for the full cost of their health benefits, and instead purchase their own health insurance on the open market.

The way things stand now, however, employers are not about to make such an offer, because doing so would de-stabilize the system. The rational employee would go out and try to get a medically under-written policy. If they succeeded, and the premium were less than the credit being offered, they would take the credit. But for the 20% of less healthy employees, this deal would be a non-starter, so of course they would stick with the group plan. This process of self-selection would then result in the claims experience for the now-small, much less healthy cohort of remaining employees rising, astronomically. So I don't think that the revolution is likely to start with existing large employers.

The Disruptive Force

I think the revolution will begin with start-up companies.

If I were a small knowledge-based company, such as a software or consulting firm, I would be very tempted to try a different approach to health insurance. An approach that could give me both a cost and recruiting advantage. Instead of having a traditional, non-underwritten group plan, I think I would try to partner with an insurer(s) to provide my employees with individual policies. It would take some selling and education to get employees and candidates to understand the value proposition, but, as an employer, if you feel like your core demographic is likely to be pretty healthy, why not press that advantage?
I would pay my employees somewhat more in salary, to make up for the fact that they had to buy their own benefits. But since those benefits would be medically under-written, the overall cost to the employee should be relatively lower. One key aspect of the partnership would be to figure out a way to provide expedited approvals—say within 1 week, for standard cases. No underwriting short-cuts, mind you, just making sure the process is very efficient, and little time is lost to waiting in work queues. To make this work, it would be important to match the time for approval to the same kind of timescale that might be expected for acceptance of an offer of employment.
Another aspect to the partnership would be education. Employees are notoriously conservative and gun-shy about their health insurance. So there would have to be some education involved in making sure they see how this is a mutually beneficial arrangement. I think that having an arms-length partner, in the form of an insurance company, would be helpful in performing that employee education. There really are some significant advantages for the employee:

  1. Net-net, the employees are sharing in the economies of this system, in the form of higher salaries that more than offset the cost to them to buy their health benefits.

  2. Guaranteed-renewable individual insurance is theirs, and nobody can take it away from them, as long as they pay their premiums. So if their spouse gets cancer, and they get laid off, or want to start their own business, they never need lose a minute of sleep over health insurance concerns complicating those other life decisions.

  3. The individual business risk pool is much larger than for any one company, so they don't have to worry that their premiums will go up unexpectedly due to one or two very sick co-workers.

#2 is big. Once a person gets their minds around this, it turns individual insurance into a very desirable thing. In fact, it would be a modest additional source of employment advantage--if other employers don't offer the same deal, the employee who wanted to change employers would have to either give up their individual policy, or suffer the intolerable penalty of essentially paying twice for the same insurance.

The most obvious downside for the employer would be losing out on candidates who do not qualify for medically under-written insurance. But since that number is typically only about 20% of applicants, it isn't a huge penalty to incur. Moreover, considering that those 20% are presumably much more likely to miss work for health-related problems, then viewed from a very mercenary point of view, it doesn't seem like too high a price.
So it seems to me that this revolution would start, like many social revolutions, rather quietly. A few small startups would be pursuing this strategy. But over time, some of those startups would grow larger. Eventually, their established, traditional competitors would inevitably become aware of the cost advantage enjoyed, and would be pressured to react. Once started, I think the trend would become hard to stop. For a quick comparison of a different, but snow-balling compensation trend, think about the disappearance of traditional, guaranteed-benefit pensions.

Tax Considerations

A partial impediment to this is tax implications. Employer-sponsored health insurance is purchased with pre-tax dollars. Privately purchased health insurance does not inherently provide for a comparable tax break, unless the purchaser is not self-employed and incorporated. President Bush did propose that extending that very tax benefit to all purchasers of private health insurance, but it didn't get put into law. It is still on the agenda of some conservatives, though. In the meantime, there are partial measures which would probably work pretty well for the situation I am describing, namely medical FSAs and HRAs.

The above is analysis, not a policy editorial. I don't know if it this development would be a "good" thing or not. I just think it may happen.


Cory Doctorow and Glenn Reynolds--not normally on the same side--both think the de-coupling of insurance from employment would be a good thing for innovation.
I heard some kind of panel interview piece on NPR where the conservative guy was also advocating de-coupling.

It seems possible that the drumbeat for reform will change conditions on the ground, rending this prediction obsolete.


  1. So, instead of increasing the salary to compensate for the loss of benefits, why not just pay the regular salary, and a fixed amount for health insurance? It's the same thing, I know, but you would be using the argument from the beginning of the article, and it would be easier to understand, particularly if you can show some kind of material from the insurance company with an idea of the premiums.

    I am an advocate of individual insurance, although there seem to be many forces shaping this market that do not follow the logic of markets.

  2. The fixed amount could work, via a HRA.

    (In some ways, I think it would be preferable to sever the linkage between compensation and health insurance. So just as I don't necessarily expect my employer to pay me more because the price of gas is going up, nor would I just because the price of healthcare is going up. But I'm not in the realm of ideology, not pragmatism.)

  3. I'll have to look into the Individual Insurance Plans. It will ber interesting to see cost vs coverage.