Small Businesses, Large Problems

Health Care Costs Hit Small Employers

Ellen-Marie Whelan shows that small businesses are hit extra hard by rising health costs, and need extra help to help their employees in this health care issue brief.

In This Issue

Health Care Costs Hit Small Employers

Small Business Owner

SOURCE: AP/Steve Yeater

Sam Manolakas, owner of Brookfield’s, cleans up a serving station at his restaurant. Manolakas says he cannot afford his workers’ rising health care premiums. But his workers earn so little, neither can they.

If rising health insurance premiums are giving employers a cold, they are giving small businesses the flu. Since President George W. Bush took office, the number of businesses that offer health insurance to their workers has declined 8 percent, from 69 percent in 2000 to 63 percent in 2008.

This decline in health care benefits is almost entirely due to the shrinking number of small businesses that can afford to offer benefits, especially among the smallest employers. Only 49 percent of firms with fewer than 10 workers offered insurance in 2008. And when firms do offer insurance, they often can only afford to do so by requiring employees to pay a higher share of the costs of premiums than large businesses do. Small business owners and their employees account for the largest share of the uninsured population—an estimated 27 million of the 47 million Americans without health insurance.

Why do small businesses face a greater struggle to provide health insurance than other employers? Generally speaking, small businesses have three major disadvantages that do not affect larger employers. First, risk is shared by a smaller number of workers, which makes them more expensive to insure as a group. Second, small businesses lose economies of scale, which makes their administrative costs more expensive. Finally, small business premiums can vary more from business to business and year to year, making premiums unpredictable and, in some cases, exorbitantly expensive.

Conservatives have suggested that the solution is further deregulating the health care market and shifting the burden for buying insurance to individuals. But experience has shown that insurers try to cover only the healthiest individuals possible and avoid the cost of individuals who need care. And the individual market faces even more concentrated problems with risk pooling and high administrative costs than small businesses.

Real solutions for small businesses will facilitate pooling risk, reduce the administrative costs of purchasing coverage, allow small businesses to negotiate the cost of coverage on a more even playing field, and ensure that premiums are set fairly and consistently. In some states, these steps should also improve the situation for workers who must buy insurance on their own because their employers cannot afford or choose not to offer insurance.

Pooling risk

Risk pooling is the foundation of insurance. Your health insurance premium subsidizes the costs when someone else gets sick, and other people’s premiums, in turn, subsidize your costs when you get sick. The more people who share that risk, the less each individual needs to pay into the pool.

A company with over 50,000 employees will have risk broadly distributed, so the cost of insuring each individual employee is lower. But a business with only five employees is in a very different situation because not all people are equally likely to need health care. Insurers use a process called “underwriting” to determine how high the health care costs of an individual business’ employees are likely to be. They then divide this assessment across the number of workers and set premiums accordingly.

In large businesses, employees who are more likely to use care—older workers and those with pre-existing conditions—are balanced out by younger, healthier employees. But smaller employers may have a lopsided pool of workers, so the risk posed by those more likely to use care is not pooled with enough workers less likely to use it.

Administrative costs

Small businesses cannot spread their higher administrative costs over a large number of workers. Many of the expenses of administering health insurance—fees to insurance brokers and underwriting costs—are fixed, while others are actually higher for small businesses. It takes insurers less effort to sell a single policy for 5,000 workers than 1,000 policies for 5 workers. Only 10 percent of a large business’ premiums go to administrative costs on average. But those costs account for 20 to 25 percent of a small employer’s premiums. Small businesses also do not have the market power to benefit from bulk purchasing or to negotiate for lower rates.

The result, according to the National Federation of Independent Businesses, is that small employers pay an average of 18 percent more than large firms for identical coverage for their employees.

Unpredictable premiums

Federal law prohibits insurers from refusing to insure a small business based on the health status of its employees, but only a few states prohibit insurers from significantly raising rates for employers who are most likely to use services. And insurers can charge more from year to year, sometimes so much more that they force employers to drop coverage.

Imagine a small business has mostly young, healthy workers in 2008. Then, one of these workers gives birth to a premature baby who requires hundreds of thousands of dollars in care. Or a once-healthy worker develops a chronic condition. When it comes time to renew the policy in 2009, the insurer might raise rates substantially because of these expenses. Premiums could suddenly be prohibitive, leaving the employer no choice but to reduce or drop coverage.

Individual insurance

Workers who do not get insurance through their employers can try to buy insurance on their own. But for many of the same reasons that small businesses pay more than large ones—they cannot share their risk and they have higher administrative costs—individuals must pay more or accept less generous coverage than they would if they were insured through an employer.

And individuals might not be able to get coverage at all. There are only a handful of “guaranteed issue” states, where insurers are required to sell someone coverage even if they have a pre-existing condition. Even fewer states prohibit insurers from charging more to patients with pre-existing conditions, so coverage may be unaffordable even if it is available. Individuals with pre-existing conditions also often face waiting periods on coverage for the conditions for which they most need treatment. More than two-thirds of people who have looked into buying individual policies say they have found it difficult or impossible to find affordable coverage.

Retiree benefits

The problem in small business insurance is even more acute when it comes to insuring retirees. According to a 2006 study, only 9 percent of businesses with fewer than 25 employees offered retiree health insurance, while 25 percent of those with 26-100 employees did so. In contrast, half of firms with more than 100 employees offered insurance to their retirees. Seniors have access to Medicare, but that only covers 80 percent of health care costs. Those who retire before age 65 are especially in trouble if they do not have health insurance through their former employers, because affordable private options for people in late middle age are very hard to find.

Reasons and Recommendations for Small Businesses to Offer Insurance

Given the many hurdles small businesses must overcome to offer health coverage, what kinds of businesses still offer insurance and why?

Not all small employers are equally likely—or unlikely—to offer health benefits. Small firms that must compete heavily with large employers for workers are far more likely to offer insurance. These are ones that also tend to pay higher wages, have lower turnover rates, and have been in business longer. Businesses in sectors that are highly unionized also are far more likely to offer insurance. According to research from the Association for Healthcare Research and Quality, small firms in the mining and manufacturing, wholesale trade, and professional services are the most likely to offer health insurance, while those in agriculture and retail are the least likely.

In addition to competing for workers, employers might want to offer health insurance because it allows them to stretch payroll dollars further. Because employer premiums are not taxed under the current system, employers can effectively give their workers more take-home pay than if they simply gave the same amount to their employees in their paycheck.

Employers may also reasonably believe that a healthier workforce is a more productive workforce, and so covering workers will lead to fewer missed workdays and a more effective workplace.

States have tried various approaches to help small businesses that want to offer coverage. Many states have put in “community rating” requirements, which oblige insurers to charge the same rate to each firm based on simple demographic data instead of assessing the risk of each business separately. This reduces costs for businesses with workers who have pre-existing conditions, though coverage can remain unaffordable without subsidies. States including Montana, New York, and New Mexico are experimenting with a combination of tax breaks, subsidies, and other mechanisms to ease the cost of covering low-income or high-cost workers.

Another proposed solution is to create purchasing pools that bring together small businesses and individuals who are purchasing insurance on their own. The best-known experiment with this arrangement may be the Massachusetts Connector, though its small business connector has not yet been launched. Purchasing cooperatives also can standardize plans and simplify the process of choosing among them, reducing the hassle of purchasing insurance.

Making these arrangements work, however, requires measures that ensure they enhance risk pooling. Regulations are needed that prevent insurers from cherry picking the healthiest groups while leaving the people most likely to need services on their own. Additionally, steps must be taken to address the problem of “adverse selection,” where businesses with the healthiest workers opt out of insurance pools leaving only the more expensive employees in the insurance pool. It should also be noted that “Association Health Plan” proposals promoted by some conservatives fall short, because they would allow insurers to skirt state regulations that offer consumer protections and would be optional arrangements that do not guarantee a balanced population.

Some states have taken an initial step to improve the small business insurance market by replacing underwriting with a “community rating” system in which premiums are set based on the age and location of a business instead of the health status of the individual workers. This would bring down the cost for businesses with higher risk populations and guard against radical changes in premiums from year to year.

Encouraging small businesses to offer insurance will be an ongoing challenge, which is made dramatically clear by a recent Mercer poll in which 43 percent of all employers without employee plans said they could not offer insurance because of price.

For Further Reading

The Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits 2008 Annual Survey, September 2008.

Linda J. Blumberg, Making Health Care Reform Work for Small Businesses, Testimony Before the Committee on Small Business, United States House of Representatives, September 18, 2008.

“The Future of Employment-Based Health Benefits: Will Employers Reach a Tipping Point?” Employee Benefit Research Institute Notes, February 2008.

“Risky Business: When Mom and Pop Buy Health Insurance for Their Employees,” The Commonwealth Fund, April 21, 2004.

Thomas Buchmueller, Richard W. Johnson, Anthony T. Lo Sasso, “Trends in Retiree Health Insurance, 1997-2003.” Health Affairs, Nov/Dec 2006.




The Bottom Line

Employers shouldn’t be responsible for providing costly health care benefits.

More than half of Americans currently get their health insurance through an employer.

As long as employer-based insurance remains the backbone of the private insurance system, expanding access to coverage means helping small businesses.

Instead of helping small businesses offer insurance, it would be better to give individuals incentives to buy insurance on their own.

More than two-thirds of people who have looked into buying individual policies say they have found it difficult or impossible to find affordable coverage.

Unless there is a proposal for a viable alternative to the employer-based insurance system, leaving individuals to find insurance on their own will put their access to care in greater jeopardy.

Small businesses should be able to form Association Health Plans, voluntarily joining together to buy insurance.

Because Association Health Plans allow insurers to circumvent state regulations protecting consumers, they become tools for segmenting risk, not sharing it.

Only purchasing arrangements that spread risk broadly will ultimately help make insurance more affordable.

Employees should be given the option of getting insurance on their own if they find they can get a cheaper plan that doesn’t cover services they don’t think they need.

If younger and healthier employees opt out of coverage offered by small businesses, employers may find themselves insuring only the sicker, more expensive employees. Or they may not be able to enroll enough workers in order to get an insurer to sell them a policy.

Health insurance works best when a diverse group of workers are insured. Segmenting the market will make it harder to insure those who most need coverage.

In the News

Workplace Health Premiums Continue Climb But Rate Slows
New reports released last month show businesses’ health costs continue to rise, with small businesses feeling the effects most dramatically. One-third of workers employed at small firms now face deductibles of more than $1,000.

Small Business Is Latest Focus in Health Fight
The New York Times surveys the reactions in the states and in Congress to small businesses’ health care woes, which is now “one of the biggest causes” of the growing ranks of the uninsured.

The Last Word

“[H]ard-working small business owners want comprehensive reform now. It should be no surprise that they are willing to be part of the solution, and are flexible as to the exact form it takes…. Small businesses should rise or fall based upon innovation, product quality and hard work. Our health-care crisis has created an external barrier to free and fair competition that impedes our economic success.”

John Arensmeyer, San Francisco Business Times, September 7-13, 2007.

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