David Leonhardt makes an interesting argument about why employers don't choose employee health insurance carefully. The argument is interesting because it is wrong but in a subtle way.
The bottom line: The cost of insurance comes mostly out of employees' paychecks. If insurance costs more, employees are generally paid less. If insurance costs less, employees are paid more. The cost of insurance does not have a big effect on employers’ overall compensation costs.
That’s why no one should be surprised that employers don’t make for good consumers of insurance. And it’s why insurers are not operating in a very competitive marketplace.
The premise is correct, employee compensation comes out of wages. The subtle mistake is to forget that this is only true in equilibrium. Imagine that a single employer was able to buy for his employees equal quality health insurance at a lower price. Would wages at that firm rise? No, an employer only has to pay workers what they could earn in another job. If other firms aren't paying more then this firm need not raise wages even though its costs have fallen. Thus an employer that reduced health insurance costs while keeping real compensation the same could pocket the savings as profit. It's only when other firms follow suit–also in an attempt to cut costs and earn excess profits–that wages at all firms rise, eliminating the excess profit everywhere.
The process produces the equilibrium. You can't have one without the other.
If you are still uncertain, here's another way of making the same point. Imagine that an employer provided his workers with better health insurance at the same cost. Employees would then flock to this employer pushing down wages and increasing that firm's profit.
So do employers fail to choose insurance carefully? Given the costs of health insurance and the profits to be made by cutting costs (holding quality constant), I have my doubts. Nevertheless, it could still be the case that giving employees more choices about which insurance firms to patronize could improve things on some margins as Leonhardt also argues in a related column today.
I do not know anyone who examines the details of health insurance plans before taking a job. At most, prospective employees check that health insurance is available. (I’m sure there are some rare exceptions.)
You are assuming that employees are capable of comparing the value of two health insurance plans, especially across employers. This is far from clear.
There are the rare instances of companies that allow employees’ choice to range across a cafeteria plan of multiple insurers (or no insurer), but it’s rare.
I’d like to see someone study those schemes to see if the employees are more rational buyers than their employers.
What fusion said. If I work at Goldman and make 400k, I’m not jumping to Morgan Stanley for the same coin just because they have a better dental plan.
You ivory tower types don’t get out much.
Meter’s probably right. That’s why Goldman and other big companies NEVER offer health care/dental/minor benefits to their best paid employees. After all, why jump ship because you have NO health plan? It’s so trivial compared to a $500K salary. In fact, why bother to offer any minor fringe benefits in the first place?
Oh, you mean they do have health plans? That must be because these companies are so generous and charitable.
Great post Alex. This is why you were horribly wrong yesterday to write a post in defense of single payer.
“The process produces the equilibrium”
Wonderful explanation.
I am reading Akerlof & Shiller, ‘Animal Spirits.’ The chapter on efficiency wages is relevant to this discussion. Wage payments are not in equilibrium; workers get a premium to keep them from slacking off when under light supervision. It’s easy to imagine employers negotiating heath insurance that benefits savvy workers or inattentive workers differently, whatever the rules for equitable coverage of all employees. What’s hard to see is how the efficiency wage paradigm is really affecting employer’s choice about the health care plan. My guess is the employer opts for something that looks costly but does not really yield good benefits relative to costs. And I do not mention, but one shoud not ignore, the ready possibility for corrupt practices between insurance buyer, seller, and health care provider that push up costs in such an arrangement.
The idea that employers aren’t good consumers of health care is bogus, and can be clearly seen in just one price comparison: The group employer rate vs the individual rate for the same group of individuals.
Even accounting for added administrative costs, the individual rates are much higher then the employer group rate, even tho the individual policies will almost always exclude either individuals from coverage who would be covered by the employer policy or exclude some health conditions that would be covered by the employer policy, or both.
Even for the small employer groups in the states where insurers have lax State rules, the group of 40 healthy 30-year olds will cost less than the same 40 individual policies, even accounting for the sales and billing costs. Insurers will be beating down the door to get those “free” premiums.
It’s the basic principal-agent problem, but in this case the employer is the agent and the employee is the principal.
There’s an inevitable inefficiency from this arrangement. As long as monitoring is imperfect, information is costly and/or computational ability is bounded, asking one party to act in the interests of another will not lead to the first-best outcome. That said, it’s not likely that having the employee make the purchases will lead to a first best outcome either.
So the choice is between various second-best outcomes. The data overwhelmingly suggest that the institutional arrangement we currently have for health care are far from optimal even by this criterion. Fortunately, there’s ample evidence that far superior arrangements work in practice in other nations and for particular segments of our own population (e.g. Veterans, people over 65).
“If you are still uncertain, here’s another way of making the same point. Imagine that an employer provided his workers with better health insurance at the same cost. Employees would then flock to this employer pushing down wages and increasing that firm’s profit.”
As has been mentioned a bit before – I’m not sure this is right in the real world because there is imperfect information.
Few employees inquire about the details of health insurance before choosing a job. Unless the employee has a severe condition, at most you’ll hear questions about if there’s insurance, who the insurer is, and maybe doctor limitations. So unless the employer is making a huge marketing effort on this issue, its unlikely that employees will know about the better health insurance.
Frankly, assuming the employee gets past hurdle 1 and gets health coverage details, I’m not sure that many consumers would recognize better insurance when they saw it. Most people don’t know of any resources to compare health insurance plans other than anecdotes, can’t stand the (all important) details, and get frustrated and assume coverage is the same. (When my friends bring health issues to me, and they’re all intelligent college graduates, its always “this is a health issue, it has to be covered.”)
I would imagine that unless you’re dealing with particularly sophisticated employees who have a major tax incentive to shift compensation into health insurance, (or you have a situation where the decisionmakers have the same insurance as the employees) it doesn’t pay to provide insurance beyond the level of “it doesn’t actively annoy my employees.”
Employers do negotiate inasmuch as they are able for the lowest cost deal that doesn’t aggravate their employees too much. Beyond that, their responsibility and agency is effectively zero. They do not engage in analysis of which plans have better health outcomes, and there are no cost-control tools in their arsenal for reducing expensive and unecessary services.
The fact that group rates are much lower than individual rates is not a demonstration that employers are good selectors of health care, it is a function of economies of scale and the undesirability of a class of insurees (individuals) who opt out if they consider themselves to be healthy. If you want to see how effective employers are at controlling health care costs, consider not the price they pay relative to smaller groups, but whether they are able to control costs from year to year. They cannot. Costs are rising swiftly even for large employers.
In addition to relaxing the vise of parochial regulation that limits entry to regional markets, if individuals are to choose their own health insurance, insurers must provide audited information on both costs and health outcomes, probably organized along the lines of the FDA’s food nutrition label, in order to facilitate easy comparison shopping. It would be appropriate to have the information anyway, but it will be of little use without the power to shop.
@ T J Sawyer – unions are not a helpful example. Union positions on benefits are political, not fiduciary.
mulp,
Well, maybe. Still, on a number of legal fronts group insurance is favored by the state and federal governments (this of course includes tax policy).
In NH, with a lot of small employers in a small market, the insurance law for group has responded to the employers dealing with the cost of group health insurance. The employers in NH who constantly lobby for less and cheaper government devote as much or more lobbying for the legislature to do something about their insurance costs. In NH the nature of the legislature and the open politics makes the employers’ pressure on the legislature very visible.
The individual market is the profit bone thrown to insurers – very little regulation, and that is primarily dictated by Federal law.
If employers didn’t care about health costs, they would lobby for less government, or at least for spending promoting their industry needs, but employers say health care costs are the top legislative issue.
Doesn’t anyone else remember this MR post?
This study makes use of a privately-gathered national database of insurance contracts agreed upon by a sample of large, multisite employers between 1998 and 2005. To gauge the competitiveness of the group health insurance industry, I investigate whether health insurers charge higher premiums, ceteris paribus, to more profitable firms. I find they do, and this result is not driven by cross-sectional differences across firms or plans: firms with positive profit shocks subsequently face higher premium growth, even for the same healthplans. Moreover, this relationship is strongest in geographic markets served by a small number of insurance carriers. Further analysis suggests profits act to increase employers’ switching costs, and insurers exploit this inelasticity where they have sufficient bargaining power. Given the rapid industry consolidation during the study period, these findings suggest healthcare insurers possess and exercise market power in an increasing number of geographic markets.
[Emphasis added]
mulp,
As best as I can tell, you are reinforcing my point. Group insurance is favored by the state and that explains much of what is screwed up about our health insurance system.
As best as I can tell, you are reinforcing my point. Group insurance is favored by the state and that explains much of what is screwed up about our health insurance system.
And you reinforce the point that employers care a lot about the cost of health care benefits.
You might be suggesting that eliminating group insurance is a great idea, but in a political climate where people are saying “keep government’s hands off my Medicare” because they fear change, you have no hope of changing the way everyone in the US gets their health care.
Either you are calling for the healthy 20% to pay much more than they think they should, or you will call for 50% of the people with good coverage to risk being denied any coverage at all, and the other 50% fearing they will pay a lot more, or you are calling for that evil socialized medicine.
Remember, employer based health benefits was the defense Kaiser took against socialism.
transition costs are so high that it’s far cheaper for employers to represent that their health plans are good while providing lousy ones for cheap than any other result.
That, and the average employee has no idea what the quality of any health insurance is until *after* they have a major claim, at which point *their* transition costs are even higher (because of preexisting conditions) and any change would come too late to affect their coverage for the major claim event anyway.
Employees can’t effectively shop for health care even through the hideously indirect method of shopping for employers – the system is too opaque for them to have meaningful information on which to base their choices. (This opacity is, of course, a feature, not a bug. To the other participants in the system, who control the degree of opacity.)
Thanks, mulp.
I can understand why prospective employees don’t ask about the details of the insurance program. Besides the risk of signalling a potential health issue, the plans are opaque. But they can ask people they know about the general reputation of the benefits of working at a company, including others’ experience when health problems occurred.
Besides, people are different. A healthy young person (the Goldman trader) is not going to ask about the retirement plan either. But someone with children will do their homework on the benefits.
“I’m not sure that many consumers would recognize better insurance when they saw it.”
That sounds accurate to me. In any third-payer system, how do you know if your insurance is good? All you can tell is “they approved this procedure my doctor wanted to do.” But you can’t compare the life expectancy, or any other results-based measure, of differing health insurance companies.
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