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Association Health Plans a Risky Answer to Small Firms' Health Insurance Woes

Affordability, Simplicity and Stability of Coverage More Likely Through Other Approaches

News Release
Feb. 5, 2003

Alwyn Cassil: (202) 264-3484

ASHINGTON, D.C.— Allowing small employers to band together to offer health insurance through association health plans (AHPs) poses risks to insurance market costs and stability, economist Len Nichols, Ph.D., vice president of HSC, told Congress today.

"By and large, many small employers don’t offer health insurance because they can’t afford it. In addition to direct subsidies to help low-wage workers afford coverage, any measure to help small firms offer insurance should be evaluated in a context of affordability, simplicity and stability," Nichols told the U.S. Senate Committee on Small Business and Entrepreneurship. A copy of Nichols’ testimony is available here. HSC is a nonpartisan policy research organization funded exclusively by The Robert Wood Johnson Foundation.

Small employers are much less likely to offer health insurance than large firms. According to the 2000 Medical Expenditure Panel Survey, 47 percent of firms with fewer than 50 workers offer health insurance, compared with 97 percent of firms with more than 50 workers.

Congress is considering legislation to allow small businesses to band together in association health plans to offer health insurance. AHPs would be exempt from state insurance regulations, including mandated benefits.

Contrary to popular belief, mandated benefits add relatively little to the cost of health insurance, with studies from the Congressional Budget Office, the Texas Insurance Department and others attributing about 5 percent of premium costs on average to state benefit mandates, Nichols said.

The real culprit in higher insurance costs for small firms is fixed administrative costs that are spread over a small number of workers, or lack of access to large diverse pooling arrangements. Administrative savings alone can approach 30 percent of premiums for larger groups.

Nichols cautioned that AHPs pose two potential risks. First, if exempted from state insurance regulations, AHPs might restrict membership in ways that would attract healthier-than-average enrollees, or what’s known as favorable selection. Other insurers then would be left with a disproportionate share of people in poorer health, or what’s known as adverse selection, forcing them to raise premiums for small employers outside of association health plans.

Another risk expressed by insurers during a recent HSC site visit is that average health costs for employers who join an association health plan-whose sole purpose is to purchase health insurance-could be higher than the average health costs of some individual firms. Over time, these firms might opt out of the AHP because they could get lower premiums on their own, increasing instability and leaving the AHP with a deteriorating risk pool that could lead to rapidly increasing but actuarially fair premiums over time.

"Either way, there’s a real risk that either commercial insurers or association health plans will end up with significant adverse selection, or a disproportionate share of bad risks, and continue to lose healthier risks, eventually leading to what’s known in the industry as a death spiral," Nichols said.

Since differences in administrative costs contribute the most to higher premiums for small firms, policy changes that allow small employers to become part of a large and stable group would likely result in greater affordability, simplicity and stability for small firms, Nichols said. Options Congress could consider include:

· Allow small firms to buy into existing large pools. State employee insurance pools are often the single largest in a state. Small employers could contribute what they want (governed by their competition in the labor market), employees would have lots of choices and would pay the difference. With the critical mass of state employees as a base, the administrative costs per enrollee would be minimized, the administrative apparatus would be simple and the risk pool would remain stable over time. Subsidies could also be provided to assist low-wage workers obtain coverage.

· Allow small firms to form purchasing coalitions to buy health insurance. Small firms have this right in many states now, and while some purchasing coalitions work well, many others have not. Experience to date suggests that pools formed wholly by small employers on their own are not likely to be as large or as stable as pools that would marry state employees and small firms’ workers. Federal policy makers could ensure that purchasing coalitions, or pools, are governed by the same market rules as commercial insurers outside the pools in each state. But short of subsidies, or requiring all small employers who choose to offer to purchase insurance through one combined pool, there is little policy makers can do to ensure critical mass.

·Allow small firms to buy into Medicaid or the State Children’s Health Insurance Program (SCHIP) or some new hybrid state-employer program. This option is particularly attractive for the low-wage workers who might already be eligible-either themselves or their children-for public insurance. The concept is similar to allowing employers to buy into state employee plans, but is a bit more complex because the benefit package for Medicaid is typically more comprehensive than coverage offered to state employees. Subsidies could assist low-wage workers obtain coverage without reducing core benefits. Still, allowing small employers to opt-in to the Medicaid or SCHIP purchasing apparatus would clearly offer administrative savings and a stable risk pool compared to buying insurance alone in the small group market.

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The Center for Studying Health System Change is a nonpartisan policy research organization committed to providing objective and timely insights on the nation’s changing health system to help inform policy makers and contribute to better health care policy. HSC, based in Washington, D.C., is funded exclusively by The Robert Wood Johnson Foundation and is affiliated with Mathematica Policy Research, Inc.


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