Employer-Based Health Insurance: A Balance Sheet Article critique

At the Intersection of Health, Health Care and Policy Cite this article as: U E Reinhardt Employer-based health insurance: a balance sheet Health Affairs, 18, no.6

(1999):124-132 doi: 10.1377/hlthaff.18.6.124

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C om m e n ta r y

Employer-Based Health Insurance: A Balance Sheet
A political economist sets up the credits and debits of the U.S. system of employer-based health coverage—and doesn’t like how it all adds up.
by Uwe E. Reinhardt

A
124 BALANCE SHEET

s t h e u nit ed s t at e s f ac es the dynamic global economy of the next millennium, many policy analysts and even some members of Congress have begun to wonder

whether employment-based health insurance can remain a cornerstone of the U.S. health care system. The employer-based system traces its origins to World War II, when

Congress illogically allowed employers to use fringe benefits as a means of evading the wage caps that it had imposed at the time. The system thrived in the postwar

years, when the U.S. economy ruled the world and American workers enjoyed virtually tenured jobs. Its growth has been further abetted by a tax preference that allows

employers to treat the group-insurance premiums paid on behalf of employees as tax-deductible expenses without requiring employees to pay income taxes on this part of

their compensation. In effect, this tax preference allows employed Americans to purchase health insurance out of pretax income, a privilege not extended to self-

employed or unemployed Americans. Although the employer-based insurance system covers about two-thirds of the U.S. population, it accounts for less than one-third of

total national health spending. This is because public insurance programs have become the catch basins for relatively high cost Americans—the elderly, the poor, and

the disabled. Government’s relative importance as a payer for health care is likely to grow in the next century, as the population ages. Doubts about the employer-

based health insurance system’s future have grown during the 1990s, because the system actually shrank as the economy and total employment expanded apace. About 18

percent of working adults are not now offered any health insurance by their employer.1 The more nonelderly Americans are eclipsed and left uninsured by the employer-

based system, the more
Uwe Reinhardt is James Madison Professor of Political Economy at Princeton University, Princeton, New Jersey.

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I N S U R A N C E

B A L A N C E

S H E E T

“It would be particularly difficult to eliminate the dubious tax preference now accorded the employer-based system.”
compelling is the search for a robust alternative to that system. This Commentary explores the social merits of the current system within the framework of an account

to which the system’s achievements are credited and its shortcomings debited. Severe limitations of space necessarily keep the discussion somewhat superficial. Readers

therefore are referred to two earlier papers, on which the present discussion draws.2

The System’s Credits
n The status quo. One of the chief advantages often claimed for the employer-based system is that it is there. At a purely practical level, the argument is compelling.

So far, it remains the most effective mechanism for pooling of health insurance risks in the private health insurance market. It would be particularly difficult to

eliminate the dubious tax preference now accorded the employer-based system. If it were proposed to add employer-paid premiums to workers’ taxable income, then the

imputed incomes probably would have to be adjusted for each employee’s actuarial risk. After all, if a company paid an average premium of $5,000 per worker for all of

its employees, would younger and healthier employees accept the addition of $5,000 to their taxable income? To spare employers the daunting task of making these

imputations, the easiest way to eliminate the tax preference might be simply to exclude employer-paid premiums from employers’ tax-deductible business expenses. That

policy, however, would be likely to meet stiff political opposition from the very people on whom Congress relies for campaign financing. n Risk pooling. Within a given

firm, the group policies customary under the employer-based system tend to force healthier and younger employees to cross-subsidize the health insurance of older or

sicker employees within the same company. Persons who favor the socialization of the financial risk of ill health—myself included—therefore will credit employer

coverage for risk pooling that typically is much broader than that in the market for individually purchased health insurance. Of course, if one took as a benchmark the

even broader risk pooling under genuine social insurance systems, such as Medicare or the European health systems, then the extent of risk pooling achieved by the

employer-based system must be judged rather limited and spotty. That is particularly so for small
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COMMENTARY

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“The worst shortcoming of the employer-based system is that protection of entire families is tied to a particular job.”
firms with experience-rated group policies. n Innovation through decentralization. It has been argued that relative to highly centralized, government-controlled health

insurance systems, the relatively unregulated, decentralized U.S. employer-based system naturally offers greater opportunity for experimentation and innovation in the

procurement of health care. There is something to this claim, although it can be exaggerated. For example, the now world-famous diagnosis-related group (DRG) system

for paying hospitals and the resource-based relative value scale (RBRVS) for paying physicians were developed not in the private sector but by Medicare. Similarly, the

survey instrument of the increasingly popular Consumer Assessment of Health Plans (CAHPS) was developed by the Agency for Health Care Policy and Research (AHCPR) of

the U.S. Department of Health and Human Services. Finally, many of the managed care techniques now taken as inventions of American employer-based health insurance

actually have been used for decades in the government-controlled health systems of other nations. One thinks here of physician profiles, multitier pricing for

pharmaceuticals, hospitalists, home care as a substitute for inpatient care, and the like.3 Even so, in fairness one probably ought to give credit to the employer-

based system for some of its recent innovations in the procurement of health care, and that credit is hereby entered. n Consumers’ preferences. It may be argued that

the employerbased system deserves credit for reflecting the preferences of the American people. The argument seems to be that Americans like the comfortable

paternalism built into the system. Although that may be so, one wonders whether this argument does not confuse a preference for private health insurance with a

preference for employerbased health insurance. If Congress had seen fit to allow employers to procure food and automobiles for employees on similarly tax-favored

terms, then today employer-provided food and automobiles probably would seem to be preferred by Americans, too, especially if unemployed Americans did not enjoy the

same privilege. Under those circumstances, Americans probably would favor that system even if their choice and use of automobiles and food were paternalistically

“managed” by their employers, as is their health care today.