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Friday, September 17, 2004

Who Loses When Businesses Drop Health Insurance?

An anonymous commentator asks, "I don't quite understand the argument that workers will be left out in the cold [when business stop providing health insurance]. Isn't that equivalent to saying that they will experience a decrease in their effective wages, and wouldn't employers reduce wages now if they could?" That's a good question that I didn't really give much thought to in my previous post.

Kaiser estimates that 2.6 million workers will lose health insurance under the Bush plan. The idea is that at some firms, most workers would prefer to buy health insurance in the private market, garner Bush's new tax breaks, and get higher wages instead of employer-based health insurance.

The catch is that some workers get large benefits from employer-based health insurance -- the old and the sick, those with sick children or spouses. They won't be able to buy matching coverage in the private market except at a much higher price than their raises, if they can buy it at all.

By the same token, some workers don't get much benefit from health insurance -- the young and healthy. They may choose to save their money and forego health insurance. But some of them will inevitably become sick or injured, and become a burden on the taxpayers or their family.

On average, everybody loses, because private insurance has serious adverse selection problems. Private insurers charge a premium on the assumption that anyone who wants insurance must be sicker than average. So private insurance will allow for a lot less risk-sharing.

So, I rest my claim that some workers will lose out on the observed fact that some workers cost more to insure than others, but they don't seem to "pay" extra for their insurance (in the form of lower wages).

So I think it's true in practice, but big deal: is it true in theory? In a frictionless neoclassical world, I suppose that it might not make any difference whether the health insurance was employment-based or private. Employers would charge the sickly more for their health insurance, just as insurance companies do. Obviously, employers don't do this, presumably because it would be costly to screen new hires this way, not to mention probably being illegal. So these frictions are useful: they're what allow us to escape the usual adverse selection problems of insurance markets and pool risks among employees at a particular firm.

Also, I think many employers make an implicit bargain with their workers to cover the increased insurance costs if the worker develops a costly illness. So even if all workers are offered the same expected compensation when they're first hired, over time some will turn out to need more health care than others. If the employer decides to break the deal and drop health insurance, some workers are going to gain and some are going to lose big. It's really a mistake for the government to use tax breaks to encourage firms to break these implicit contract with their workers.

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