A growing number of small businesses have tried to reduce their health-care costs in recent years by replacing traditional insurance with self-insured plans. That means that instead of buying policies from big insurers such as Aetna (AET) or WellPoint (WLP), the company sets aside money to pay for workers’ medical claims directly. The practice is common at big companies, where a large number of claims make it easier to predict health-care costs. Most small employers, who can face exploding health bills from a single unexpected illness or injury, have still stuck to conventional insurance.
A new report today from the progressive Washington advocacy group Center for American Progress warns that a shift toward self-insurance by small companies may put their workers’ health and their own finances at risk. Self-insured plans aren’t subject to some of the requirements of health reform, such as the minimum coverage requirements that traditional policies must now provide. And as the CAP report points out, self-insuring can save companies real money if their workers are healthy:
“As long as these employee groups remain young and healthy, there are few incentives for employers to join the fully insured risk pool that includes older, less healthy individuals, who increase the price of insurance premiums.”
But if costs go up—if an employee or family member has a car accident, say, or gets cancer or HIV—the company might choose to buy an insurance policy, where the risk will be shared with other employers. Under Obamacare, insurers aren’t allowed to charge companies with sicker workers higher premiums. This could raise costs for other groups buying insurance:
“Churning between the self- and fully funded markets would allow small businesses to capitalize on the fully funded and regulated market only when employer risk is high without otherwise participating in the risk pool. This adverse selection could, in turn, raise premiums in the fully funded small group market.”
Think of the health insurance system as a spectrum of how much risk is shared. At one extreme would be a system where everybody pays the same amount into a pool of money (a “single payer”) that pays for everybody’s care. Risk is shared completely. At the other extreme, everyone would bear his or her own medical risk directly. There’s no insurance, and people are on their own to pay for the care they need.
The U.S. health-care system operates somewhere in between—risk pools are sliced and diced by geography, employer, and type of insurance. That creates incentives for “adverse selection,” or gaming the system by sharing risk only when you’re likely to have high costs, and going it alone when costs are low.
Some states are trying to rein in the practice of self-insurance by small businesses, mostly by regulating stop-loss insurance. Those are secondary policies that employers buy that will pay out if medical claims get very costly. Last month Colorado passed a law (pdf) to limit how stop-loss policies can be sold to small businesses. It’s not clear yet how much self-insurance by small businesses might affect premium costs in the broader marketplace. But it’s clearly something regulators are watching.