This document provides a history of the employer-provided health benefits system in the United States. It discusses how private health insurance originated in the early 20th century led by hospitals and doctors. During World War II, employer-provided health benefits rose as the government exempted such benefits from wage controls. The system expanded further in the post-war years. Organized labor also came to support the employer-based model through collective bargaining. However, the system has led to issues such as inequality and a lack of choice. Several presidential administrations have attempted but failed to reform the system through an employer mandate.

1. © 2005 by Eileen Weinberg. All Rights Reserved.
The Employer-Provided Health Benefits System
Eileen Weinberg
April 27, 2005

2. 1
INTRODUCTION
2
HISTORY
OF
THE
EMPLOYER-­‐PROVIDED
HEALTH
BENEFITS
SYSTEM
3
ORIGINS
OF
PRIVATE
HEALTH
INSURANCE
3
RISE
OF
THE
EMPLOYER-­‐BASED
SYSTEM
4
ORGANIZED
LABOR
6
EMPLOYER
MANDATES
8
CHARACTERISTICS
OF
THE
EMPLOYER-­‐PROVIDED
HEALTH
BENEFITS
SYSTEM
11
EXPERIENCE-­‐RATING
11
SELF-­‐INSURING
12
PROBLEMS
OF
THE
EMPLOYER-­‐PROVIDED
HEALTH
BENEFITS
SYSTEM
14
SMALL
BUSINESSES
14
CASE
STUDY:
EMPLOYER
MANDATE
AND
HAWAII
16
INEQUALITY
17
CASE
STUDY:
COMMUNITY
RATING
AND
ROCHESTER,
NY
20
ILLOGICAL
CONNECTION
BETWEEN
EMPLOYMENT
AND
HEALTH
COVERAGE
21
RISK
SELECTION
AND
RISKS
TO
EMPLOYMENT
22
LACK
OF
PORTABILITY
AND
PERMANENCE
23
LACK
OF
CHOICE
AND
MARKET
FORCES
24
WHO
IS
AT
RISK
WITH
SELF-­‐INSURANCE?
26
RISING
COSTS
AND
RECENT
DEVELOPMENTS
27
HEALTH
SAVINGS
ACCOUNTS
28
CONCLUSION
30
BIBLIOGRAPHY
31

3. 2
Introduction
The United States arrangement of health insurance provision is unique when
compared to other industrialized countries. The system has a highly complex interaction
between largely private insurers and providers working with some public insurers and
providers, as well as exceptionally higher total health spending.1
However, another
factor that is unique to the American system is the role of the employer as the provider of
access to health insurance for their employees and dependents as part of the workers’
total fringe benefits package. The institution of employer-based provision of health care
creates many issues that are overlooked or disregarded, in the basic debate of the merits
of public versus private insurance.
An employer’s decision to offer health care benefits to their employees is
voluntary and completely discretionary. Despite that, two-thirds of Americans under 65
receive their health insurance through an employer, either as an employee, spouse or
dependent of an employee, or a retiree—that is approximately 140 million people.2
Employers chose to offer health insurance benefits to their employees for many prudent
reasons, and many, especially those in large and mid-sized companies, prefer their role in
health benefits provision as an alternative to government intervention or a government
take-over of the system. Most employers who provide health insurance also subsidize the
cost of the premiums, paying on average 86 percent of the cost for their employees,
1
Anderson et al., 89.
2
Statistics are from 1993. Institute of Medicine, Employment and Health Benefits. A Connection
at Risk. Marilyn J. Field and Harold T. Shapiro, editors. (Washington, D.C.: National Academy Press,
1993), 1.

4. 3
although this usually means a decrease in wage income. However, employers today are
expressing their concerns over the ever-rising cost of providing health care benefits for
their employees and the negative effect these costs are having on their companies’
finances; many employers are actively seeking changes to the system.3
History of the Employer-Provided Health Benefits System
Origins of Private Health Insurance
Health insurance systems were formalized early in the twentieth century because
of the initiative taken on by providers—hospitals and physicians—trying to secure an
income. Before World War I, the federal government began considering legislation that
would provide medical insurance to Americans on both the federal and state level, but the
initiatives failed because of interest group opposition, and the country’s entry into the
war. By 1920, the American Medical Association, or AMA, the largest interest group of
physicians, enjoying their control over the current system, forcefully opposed any
legislation requiring compulsory or government-provided insurance.4
As a means of pre-
empting what they considered a far worse alternative, organized medicine began to offer
forms of voluntary insurance. The American Hospital Association established the first
Blue Cross group and the California Medical Association established the first Blue
3
Kaiser Family Foundation and Health Research and Educational Trust, “Employer Health
Benefits: 2004 Summary of Findings,” 3.
4
Institute of Medicine, 55, 58, 59, 63.

5. 4
Shield. Hospital and physician control over “the Blues” guaranteed them a generous
reimbursement for their services.5
Successive attempts to pass legislation for a universal, government-based system
all failed. The provision was excluded from the Social Security Act of 1935 during the
Roosevelt administration; attempts to pass national health insurance by the Truman
administration failed because of a powerful public relations campaign led by the AMA,
and their success at demonizing universal insurance as “socialized medicine.”6
At this
time physicians also opposed employer-provided health insurance, because they
perceived the collective establishment and purchasing power of the employer as a
mechanism that could challenge their autonomy in health care provision, and thus
ultimately their income, much the same as a government-run system.
Rise of the Employer-based System
The “employee group” was the foundation upon which private health insurance
began, as it was simpler to market and sell plans to employer for a group, rather than
servicing all the employees individually. The employees of the company comprised an
already defined group on which to determine risk. Companies often provided a large
enough pool of consumers through which to spread risk, reducing costs by allowing for
5
Thomas S. Bodenheimer and Kevin Grumbach, Understanding Health Policy: A Clinical
Approach, 4th ed. (New York: McGraw-Hill, 2005), 7 and Institute of Medicine, 187.
6
Institute of Medicine, 64.

6. 5
cost shifting from the sick to the healthy. The very nature of insuring actively employed
individuals, the employee group tended to avoid higher risk people.7
In 1943, the War Labor Board allowed contributions to insurance or pension
funds to be free from wartime wage controls, thereby enhancing employer incentives to
provide health benefits. Employment-based health care benefits became a means by
which employers could compete for the shortage-laden workforce. Another financial
incentive was given to employers when the IRS declared employer contributions to health
insurance premiums as exempt from the income tax.8
By the end of the war, those
enrolled in employer-based health plans tripled.9
In 1948, Blue Cross participated in the campaign against Truman's national health
plan, defending the voluntary system as the answer to the needs of all Americans. Blue
Cross was really only interested in employed, middle-class Americans, and limited their
marketing and enrollment to that demographic. Even so, Blue Cross supported the idea
of government subsidies for the indigent, so that in the event of non-payment the costs of
their medical expenses would not be shifted onto paying Blue Cross customers.
7
Gary Claxton, “How Private Insurance Works: A Primer,” Kaiser Family Foundation (April
2002), 6 and Institute of Medicine, 67.
8
Jacob S. Hacker, The Divided Welfare State: The Battle over Public and Private Social Benefits
in the United States (Cambridge: Cambridge University Press, 2002), 217.
9
Bodenheimer et al., 7, Institute of Medicine, 70, and Marie Gottschalk, The Shadow Welfare
State: Labor, Business, and the Politics of Health Care in the United States (Ithaca: Cornell University
Press, 2000), 42.

7. 6
However, the company could not fight strongly for these subsidies in order to avoid
drawing attention the obvious shortcomings of the voluntary system.10
In 1965, the government established Medicare and Medicaid, to provide coverage
for the elderly, the disabled, and Welfare recipients. Proponents of nationalized health
saw Medicare and Medicaid as the first steps towards expanded coverage that would
eventually lead to a national health plan. However, Medicare gained its widespread
support for government intervention on the behalf of the elderly, because they were the
exception to the employer-based system: by providing for the elderly, Medicare would
allow the voluntary tradition to continue. Insurance companies were not seeking to enroll
the populations that were primarily outside of the work force as customers anyway.11
Medicare was linked to Social Security as an earned right: “individual citizens earn their
right to a decent retirement by virtue of their contributions during their working years.”12
Organized Labor
The institution of employment-based health benefits gained an unlikely, if
somewhat reluctant, ally in organized labor. In 1947, over a veto by President Truman,
Congress passed the Taft-Hartly Act, officially known as the Labor-Management
Relations Act. Designed to severly restrict the authority of labor unions (Truman called
it a slave-labor bill) an unintended consequence of the act resulted from an ambiguity
10
David J Rothman, Beginnings Count: The Technical Imperative in American Health Care (New
York: Oxford University Press, 1997), 33-34.
11
Institute of Medicine, 65, 189, and Rothman, 80.
12
Rothman, 84.

8. 7
relating to collective bargaining requirements. The act did not ban the right of unions to
use collective bargaining as a means of fighting for welfare and pension benefits, and so
they did. These fringe benefits grew in popularity during this period and they became
known as Taft-Hartley Funds. Fights for health and welfare benefits were the cause of
more than half of the labor strikes in 1949 and early 1950.13
Many union leaders, like Walter Reuther of the United Auto Workers union
(UAW), were advocates for a universal health care system funded by the federal
government. Union members were suspicious of voluntary solutions offered by
employers out of fear that, in times of a sluggish economy, employers searching for
savings would eliminate health and pension benefits.14
In practice, labor leaders found it
more productive to concentrate their efforts on the union bargaining table, rather than on
congressional lobbying. Still, Reuther and others were convinced that as unions
increasingly demanded health care benefits from their employers, employers would
eventually join with labor and together fight for a federal plan. In the meantime,
collective bargaining became an essential mechanism by which labor leaders could build
union loyalty.
In 1974, Congress passed the Employee Retirement Income Security Act, or
ERISA, designed to help achieve uniformity in employee pension and welfare benefits
plans by setting federal minimum standards, and preempting the states from regulating
private-sector health plans. While states maintained the right to regulate the insurance
13
Institute of Medicine, 70-71.
14
Gottschalk, 42-43.

9. 8
business, ERISA removed state jurisdiction over self-insured health plans—health benefit
plans sponsored privately by individual firms, in which the firms assume the majority of
the risk—or in union Taft-Hartley funds, because neither plan is technically run by an
insurance company.15
For example, ERISA protects self-insured plans or Taft-Hartley
funds from state-level taxation. This pre-emption was very important to unions, not just
for the tax savings, but also because it removed impediments to negotiating multi-state or
national-level contracts. ERISA, therefore, succeeded in aligning the interests of
organized labor with those of large employers in support of the voluntary employer-based
system.16
Employer Mandates
In 1971, President Richard Nixon introduced his plan to secure health insurance
on a national level, by eliminating the voluntary nature of the employer-based system and
creating a mandate for employers to provide health benefits for their employees. The
President’s plan was a conservative counter measure to Senator Edward Kennedy’s
Health Service Act of 1970, another attempt to legislate a national health plan funded
through a payroll tax that would eliminate commercial insurers. Nixon’s intention with
the employer mandate was to reconcile the interests of the state, labor, and business by
15
Institute of Medicine, 82, Gottschalk, 53-54, Polzer et al., Karl and Patricia A. Butler.
“Employee Health Plan Protections Under ERISA: How well are consumers protected under managed care
and “self-insured” employer insurance plans?” Health Affairs (September 1997-October 1997), and Robert
W. Seifert and Nancy Turnbull, “An Advocate’s Guide to the Private Health Insurance Market,” The
Access Project, (2001), 8.
16
Gottschalk, 52.

10. 9
preserving the private insurance industry. Nixon justified the mandate by comparing it to
minimum wage requirements or occupational health and safety standards.17
Advocates of national health insurance, like Senator Kennedy, and many labor
leaders opposed the plan when introduced in 1971. They objected to its preservation of
the private health insurance industry, which so many considered a large barrier to access.
They also saw an employer mandate as a regressive tax that would fuel job
discrimination. Perhaps most significantly, the employer mandate fell far short of
universal coverage.18
As the debate continued, by the end of the decade organized labor
felt a growing concern for the struggling economy and began to see an employer mandate
as a means of incremental improvements towards the ultimate goal of universal coverage.
The political climate also shifted and political leaders, including then President Jimmy
Carter and Senator Kennedy came to endorse the employer mandate.
When organized labor and democratic leaders first began to support the employer
mandate, it was considered a radical shift in ideology; over the next 15 years, the degree
of the shift was largely forgotten, and the employer mandate became viewed as more of a
conservative position.19
The Carter administration saw prudence in an employer mandate
since it sought to preserve the insurance industry and minimize the impact on the
financially strapped federal government. However, the administration diverged from
labor because Carter insisted on requiring employee cost sharing, a stipulation that labor
17
Gottschalk, 67-69.
18
Bodenheimer et al., 161 and Gottschalk, 69, 73, 78.
19
Gottschalk, 68, 75-76, 78, 116.

11. 10
strongly opposed.20
The employer mandate never satisfied enough of the players to gain
real momentum, and liberals and labor leaders remained frustrated by the deficiencies of
the employer-based system. The economy was suffering through the 1970s making any
increase in government funding necessary to support the mandate difficult to envision; in
the 1980s, the trend was for government to avoid any intervention on social issues.21
In 1993, President Clinton proposed universal health insurance using the
employer mandate as the plan’s anchor. Clinton was trying to expand coverage by
building on the historically inherited mechanisms of the current system, believing that the
employer mandate formula was not radical and would not have an adverse affect on
employment. However, those who stood to gain the most from the plan, the uninsured,
were not organized and were very weak politically. The multitude of other interest
groups, all seeking to preserve different parts of the current system, created a deadlock of
lack of consensus, and the Clinton plan ultimately died in Congress without ever coming
to a vote.22
There have been no plans for major reforms since the failure of the Clinton
plan.
20
Gottschalk, 79, 81.
21
Institute of Medicine, 254.
22
Bodenheimer et al., 161, Gottschalk, 115-116, Institute of Medicine, 264-265.

12. 11
Characteristics of the Employer-Provided Health Benefits System
Experience-Rating
The employee group is “the most effective mechanism for pooling of health
insurance risks in the private health insurance market.”23
The original health insurance
plans, Blue Cross and Blue Shield, used a mechanism called community rating to price
premiums. This meant that the “Blues” charged the same premium to each policyholder
within a given community, spreading costs evenly amongst the healthy and sick
regardless of age, gender, health status, or any other characteristic that can increase risk.
Once the Blue Cross and Blue Shield plans established employment-based provision as
an institution, commercial insurance companies realized the profitability of the market.
In order to compete with the already established “Blues,” commercial insurance
companies introduced the use of experience rating as a means of determining cost
distribution.
Experience rating prices insurance policies using groups of varying size, usually
the employee group of a given company, with varying levels of risk. Premiums are
determined based on an assortment of characteristics of the company, such as the
industry, average age, gender composition, as well as the company’s actual medical costs.
The practice dates back to the early days of workers’ compensation insurance when
insurers realized that different occupations presented differing levels of risks to their
23
Uwe E. Reinhardt, “Employer-Based Health Insurance: A Balance Sheet,” Health Affairs
(November 1999-December 1999).

13. 12
employees, pricing premiums accordingly. The commercial insurers realized that they
could compete with the “Blues” by offering low-risk groups better rates.
Experience rating solidified the connection between employment status and health
insurance. Despite organized labor’s belief in a national health plan, unions in particular
came to benefit from the system of experience rating to reduce their health care costs.24
Unfortunately, this system also raises costs for the portion of the population that remains
in the community rated model, because costs are no longer shifted onto the low-risk, low-
cost population. Smaller groups have less room to spread costs, and are particularly
vulnerable when an individual member of that group requires care.25
Self-Insuring
An employer can choose to self-insure their employees’ health needs, which
means that the financial risk for the employees’ medical costs is assumed by the
employer rather than an insurance company.26
Employers can offer benefit packages
designed for the specific needs of their employees rather than a generic insurance plan.
Self-insuring reduces cash-flow demands on a company and allows employers to invest
funds from premiums rather than paying them to an insurance company. It is estimated
24
Bodenheimer et al., 7-8, and Institute of Medicine, 72, and Gottschalk, 57-58.
25
Milt Freudenheim, “Fewer Employers Totally Cover Health Premiums,” New York Times,
March 23, 2005, C1, and Seifert et al., 10.
26
Seifert et al., 18.

14. 13
that 65 percent of employers who offer health benefit plans self-insure, either partially or
entirely, rather than purchase insurance.27
After ERISA was enacted in 1974, self-insured plans were declared exempt from
state regulations, including state mandates on benefits, mandatory participation in state
risk pools, and state taxes on insurance premiums. As with labor unions, the ERISA
exemptions facilitate multi-state employers, because it enables them to have uniform
health plans regardless of the insurance laws for each state in which the company
operates.28
Since ERISA was enacted in 1974, only the federal government can pass
legislation relating to health benefit plans, and the federal government has preferred to
leave them largely unregulated
The Consolidated Omnibus Budget Reconciliation Act of 1985, or COBRA, Is
one of the few federal statutes. It requires employers of greater than 20 employees to
continue health benefits for former employees and their covered dependents for 18 to 36
months following termination of employment, or until a new plan begins. COBRA
essentially required group coverage to be available—though not subsidized—during
transitions in employment to avoid gaps in coverage.29
The Health Insurance Portability
and Accountability Act of 1996 limits specific exclusions from coverage, such as those
relating to preexisting conditions, and imposed guaranteed renewal and portability
requirements on small group and individual plans. Congress also imposed two specific
27
Polzer et al. Seifert et al. suggest the ratio is somewhere between one-third and one-half, 19.
28
Institute of Medicine, 83, 111, and Seifert et al., 19.
29
Institute of Medicine, 85.

15. 14
benefits mandates: minimums on length of stay for hospital maternity care and parity for
mental and physical services.30
Problems of the Employer-Provided Health Benefits System
The voluntary employment-based system of health benefit provision evolved over
the course of the twentieth century to become a strong social institution. While the
employer-based system works well for a large portion of Americans, there are many on
the periphery of the system that are unable to benefit from the arrangement.
Small Businesses
Of small business in the United States, almost 50 percent do not offer health
benefit coverage to their workers. In fact, about 40 percent of the uninsured work for
firms with 25 employees or less. The major barrier for small employers to offer health
insurance is the cost.31
Other reasons may be that their employees have alternative
sources of health insurance, their employees prefer to receive their compensation in
higher wages than in the form of benefits, and sometimes the employer does not believe
that health benefits provision is the responsibility of an employer.32
Surveys of the National Federation of Independent Business (NFIB) showed that
small business owners overwhelmingly support a government-based single-payer system
(greater than 90 percent of NFIB members) as opposed to an employer mandate.
30
Polzer et al., and Seifert et al., 19, 29.
31
Seifert et al., 17.
32
Institute of Medicine, 94.

16. 15
Compare that to a survey of Fortune 1000 executives showing only four percent support a
single-payer system.33
Health insurance is actually more expensive for small companies. One reason for
this is the inefficiencies in the administration for smaller groups, in terms of both
marketing and servicing costs.34
Companies with fewer than 50 employees see 25 to 40
percent of dollars spent on health insurance go to administrative costs, compared to
companies with greater than 500 employees for whom the administrative costs can be as
low as five percent.35
Administrative costs for individual, non-group insurance can be as
high as 50 percent of the premium. Administrative fees also increase because of higher
policy turnover associated with small businesses, which change their coverage from one
insurer to another more frequently in an effort to keep premiums prices down.36
The system of experience rating also disproportionately favors large firms:
premiums for small firms tend to be about 30 percent higher because of their increased
risk.37
Large companies are far more capable at risk pooling, in which younger, healthier
employees subsidize the older or sicker population of a company. Adverse selection says
that people who are more likely to need medical care are therefore more likely to
purchase insurance; when a small employer seeks coverage, there is a better than average
33
Gottschalk, 60-62, and Seifert et al., 10.
34
Institute of Medicine, 8, 108.
35
Gottschalk, 60.
36
Pauly, Mark, Allison Percy, and Bradley Herring, “Individual Versus Job-Based Health
Insurance: Weighing the Pros and Cons,” Health Affairs (November 1999-December 1999), and Seifert et
al., 17.
37
Gottschalk, 60.

17. 16
chance that they are doing so because of specific needs of an employee, or because the
company is in a high-risk industry. In experience rated models, this “group size factor”
increases the risk of the group.38
When commercial insurers used experience rating to market to desirable
employee groups, the higher-cost, higher-risk companies or individuals saw their
premiums rise. The loss of the low-risk customers onto whom costs can be shifted
resulted in largely unaffordable insurance premiums for those outside of the low-risk
large employee groups.39
It is perhaps not surprising that only one-third of those
employed by companies with fewer than 25 employees receive health insurance coverage
through their employer. In fact, of those Americans without health insurance, 85 percent
are in families headed by an employed individual working for a company with less than
100 employees, and more than half of these workers are full time employees.40
Case Study: Employer Mandate and Hawaii
In 1974, the state of Hawaii passed the Prepaid Health Care Act—and received a
special exemption from ERISA to allow for the state legislation in 1983—requiring
employers to provide health insurance benefits for their employees. After the mandate
was enacted, coverage within Hawaii did not increase significantly. The rate of
uninsured in Hawaii is remarkably similar to rates in the entire United States; several
38
Claxton, 6.
39
Gottschalk, 60, and Seifert et al., 10.
40
Statistics are from 1993. Institute of Medicine, 4-5.

18. 17
states without mandates have lower rates of uninsured.41
One reason for the minimal
impact of the employer mandate may be that the model must create new solutions for
individuals outside of the workforce. There are also substantial workforce exemptions:
the Hawaiian system does not require coverage for new hires, part-time employees, low-
wage workers, the self-employed, contract workers, or commission-only workers.42
Inequality
Employed individuals may lack coverage for a variety of reasons. Employers
sometimes only offer health benefits to a select group of employees, such as those who
work more than a defined number of hours. A pre-existing condition may exclude the
employee from the health benefit plan. The benefit plan may require a cost-sharing
employee that the employee is either unable or unwilling to pay.43
Often times the
employees of businesses, large and small alike, who are not offered health insurance are a
higher proportion of low-wage workers, making it more difficult to afford to purchase
non-group insurance individually.44
When an individual does not receive health insurance from an employer, already
at a disadvantage because of the absence of an employer subsidy, individual health
insurance policies are substantially more expensive due to the higher risk of the
individual and the higher marketing and administrative costs of non-group plans. Less
41
Norman K Thurston, “Labor Market Effects of Hawaii’s Mandatory Employer-Provided Health
Insurance,” Industrial and Labor Relations Review Vol 51, No. 1 (October 1997), 117-118
42
Thurston, 120, 133.
43
Institute of Medicine, 8-9, 93.
44
Pauly, and Seifert et al., 17.

19. 18
than seven percent of the U.S. population purchase individual, non-group insurance. The
unaffordability of individual health insurance can lead to a situation of “job lock” for
some, who are forced to remain at a job because they need to maintain their health
coverage.45
The tax system that supports employer-provided health insurance, by allowing for
the purchase of health care benefits from pre-tax dollars, does not extend to the self-
employed, or to those who purchase individual health insurance plans. Additionally,
unincorporated businesses cannot deduct the full cost of employee health benefits.46
Flexible Spending Accounts, in which employees may shelter pre-tax earnings to cover
out-of-pocket health spending, are only available when provided by an employer.47
A conventional theory of insurance called “actuarial fairness” suggests that
higher-risk individuals should pay more for their risk: people with bad driving records
pay more for auto insurance, and health insurance should function in the same way.
Therefore, individuals who either want or need a higher level of care should pay for it
and not require younger, healthier individuals to subsidize those costs.48
Otherwise, the
system is unfair to those low-risk individuals who will pay more than their care actually
costs. This is the strongest argument against the use of community rating to price
insurance premiums, the practice of spreading risk broadly throughout an entire
45
Reinhardt.
46
Gottschalk, 60.
47
Pauly and Reinhardt.
48
Institute of Medicine, 179-181.

20. 19
community. Despite the fact that community rating can help reduce rates overall, it is at
the increased cost for the healthier individuals in the community.49
Personal perspective may decide if the economics of actuarial fairness is indeed
fair in a social insurance scheme, especially since not all risk factors are within an
individual’s control. However, actuarial fairness does not apply within a given
workplace. Cost shifting still occurs within the employee group, within which the system
remains unfair for the younger, healthier workers. Younger workers tend to make less in
wages as compared to older workers, so the result is low-wage workers subsidizing the
medical expenses of the older, often higher-waged employees.50
During the health care debates of the early 1990s, small business owners fiercely
opposed the idea of an employer-mandate. Some larger companies argued that small
employers were socially irresponsible when they decide not to provide health insurance
to their staff, and that the large firms ultimately become responsible for those costs due to
cost shifting. Of course, that is ignoring the overall unfairness of a system that allows
those with purchasing power like large employers to demand price reductions, which
ultimately are passed onto those less fortunate.
In terms of fairness and equality, community rating is probably the most
consistent means to price health insurance. Since most individuals will move from low-
risk to higher-risk over time, actuarial fairness would eventually be achieved, but only
within a closed set of people; this is unlikely in an employee group because of the
49
Seifert et al., 48.
50
Institute of Medicine, 181 footnote, 183.

21. 20
assumption that there will be turnover. An entire community is usually larger than any
employee group and therefore can help keep costs down overall:
…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 firms with experience-rated group policies.51
Case Study: Community Rating and Rochester, NY
In 1992, The New York Times published a cover story on the success of the city of
Rochester, in Monroe County, New York, at controlling health care cost. The majority of
employers in the city are committed to the established health insurance pricing system
based on community rating. The community buys health insurance from Rochester Area
Blue Cross rather than insuring themselves in separate arrangements, as is the norm in the
rest of the nation. Competitive purchasing can reduce a large company's costs, at least for
a time, but it often increases the burden for small companies, which have few employees
over which to spread the risks.52
The smaller businesses can offer their employees the same affordable insurance
coverage as the larger employers. All the participants pay the same for their premiums,
including individual families who can buy into the plan. In this system, no one is denied
coverage based on age, sex, or pre-existing conditions. Health care costs in Rochester
were reported to be at least 25 percent less than national levels. Compared to the national
51
Reinhardt.
52
Milt Freudenheim, “Rochester Serves as Model in Controlling Health Cost,” New York Times,
August 25, 1992, A1, also in Institute of Medicine, 127.

22. 21
rate of 14 percent of individuals lacking insurance, Rochester’s uninsured was at six
percent of the population, and a follow-up study done in 2001 found Monroe County to
still be at a low of eight percent compared to 16 percent nationally.53
Eastman Kodak and Xerox are two of the city’s largest employers, and their
voluntarily participation in the community rated plan of Rochester is essential to the
plan’s success. While the large companies extend a major service to the entire
community through their participation in the city’s risk-pool, the large companies benefit
from the overall reduction in health care costs as well. In fact, the 1991 study showed
that Kodak's health costs averaged $2,100 an employee in Rochester, which was 25
percent lower than at the company's operations in other cities.54
Illogical Connection Between Employment and Health Coverage
Aside from the inequalities in cost and availability caused by the employer-based
system, there are a number of other problems caused by the unlikely connection between
employment and health coverage. Many of these problems are overlooked in discussions
on health care reform, because the debate is often between the merits of a public versus a
private system of health provisions, ignoring the anomaly of the employer as a factor.
53
Freudenheim, 1992, A1, and Nancy Wong, “Rochester, NY Health Care System Still a Model
for Success, According to Latest Harris Interactive Study,” Harris Interactive, (March 27, 2001), http://
www.harrisinteractive.com/news/printerfriend/index.asp?NewsID=256.
54
Freudenheim, 1992, A1.

23. 22
Risk Selection and Risks to Employment
In a given year, five percent of the population will account for 50 percent of
medical expenditures; 20 percent of the population will account for 80 percent. Biased
risk selection suggests that those more likely to need health care are those most likely to
purchase medical insurance. An employer who offers health benefits that their
competitors do not will attract higher-risk individuals to their employment, adversely
affecting their risk-selection. In order to keep a company’s health care costs down, an
employer can structure the benefit plan to keep risk selection low. Employers offering a
variety of plans can structure premium contributions to favor a particular plan, and by
excluding certain benefits, force high-risk individuals into plans requiring higher
employee-contributions. An employer can choose to not offer coverage for particular
high-cost treatments.55
At its worst, risk selection encourages employers to follow hiring practices that
discriminate against those in high-risk groups, like older employers, or those with pre-
existing conditions. Studies show that health insurance costs affect employers decisions
on hiring those aged 55-64: companies that offer health benefit plans are less likely to
have new hires in that age group than companies that do not offer health coverage. The
likelihood further decreases in firms with more expensive benefit plans.56
55
Institute of Medicine, 9, 169, 171-172.
56
Frank A Scott and Mark C. Berger, John E. Garen, “Do Health Insurance and Pension Costs
Reduce the Job Opportunities of Older Workers?” Industrial and Labor Relations Review Vol. 48, No. 4
(Jul., 1995), 775.

24. 23
While federal law prohibits employers from accessing information on or
performing medical examinations on employees, employers who self-insure have access
to information regarding the employee’s use of provided health benefits, and to the cost
that employee’s coverage incurs. This knowledge can be abused in many ways, and can
certainly influence decisions affecting continued employment. Largely unregulated or
dispersed health policy can support such corrupt practices. While the Americans with
Disabilities Act of 1990, or ADA, prohibits employers from requiring certain physical
examinations or from asking certain questions, it does not restrict the employers’ access
to claims data regarding the employee or family, nor does it prohibit the employer from
requiring medical underwriting or request of other information related to health
benefits.57
Lack of Portability and Permanence
When an individual in the United States workforce purchases health insurance
through their employer, that insurance is neither permanent, nor portable, but rather
temporary for the duration of the individual’s employment.58
Therefore, a worker’s
coverage can lapse because of loss of a job. In the event that the job loss is caused by an
illness, this leaves the individual in a particularly precarious situation. Family members
receiving coverage as dependents of a worker will also lose those benefits in the event of
the worker’s job loss, but also in the event of divorce, or death of the worker.59
57
Institute of Medicine, 9, 17, 147-148.
58
Reinhardt.
59
Bodenheimer et al., 17.

25. 24
Passed in 1986, COBRA intended to help prevent a lapse in coverage caused by
transitions in employment. The act allows a former employee to continue their coverage
for a limited time, by assuming the full cost of the premium payment plus a two percent
administration fee until their new coverage begins. Even without the employer subsidy,
COBRA coverage still costs less than the cost of an equivalent plan in the individual
market. However, particularly in the event of unemployment, coverage through COBRA
can be unaffordable. Only the purchase of an individual plan can offer the consumer total
portability and permanence, but as explained earlier, these plans are typically
unaffordable for those in need.60
Additionally, while COBRA will protect individuals
and families from a lapse in coverage, it does not prevent a change in plan that comes
with beginning employment with a new firm. Individuals often must change doctors
when they change jobs in order to find a provider in their new plan.61
Lack of Choice and Market Forces
Advocates of the private insurance system often demonize the concept of a single-
payer government-based system as “socialized medicine,” a phrase that evokes
nightmares of poor quality, inefficiency, and limited choice resulting from the removal of
market forces. However, the employer-based system creates a reality much like this
myth. The end-user (the employee) of health insurance is not the consumer (the
employer), since it is the employer and not the employee who actively shops for an
60
Pauly.
61
Alain C. Enthoven, “Employment-Based Health Insurance Is Failing: Now What? Health
Affairs (May 28, 2003), 7.

26. 25
insurance plan; market forces are therefore severely weakened in the employer model in
which the insurance companies do not have to compete for the end-user.62
The employer-based model gives most employees only minimal choice between
benefit plans designed by their employer. About half of covered employees are offered
only one health insurance plan by their employer; in the small companies that do offer
health insurance, there is generally no choice of plan.63
Some argue that Americans
prefer the current system in which their employers do the bulk of the work of
investigating, purchasing, and administering health insurance plans. True or not, that is a
great step away from a competitive, free-market system.
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.64
Given all of the mechanisms built into the current system that give preference to those
receiving coverage through their employer, it does not offer the end-user viable
alternatives provision of health benefits by their employer.
Finally, in terms of the public versus private debate, the American employer-
based private insurance system is not quite private. It is more accurate to describe the
system as one of private insurance for those who can afford it, and public services of the
62
Reinhardt.
63
Pauly et al., and Reinhardt.
64
Reinhardt.

27. 26
poor. Additionally, since the IRS declared employers’ contributions to health benefits
tax-deductible, by forgoing tax income, the federal government is already subsidizing the
supposedly private health insurance system.65
The federal subsidy of employer-based
health insurance is enormous, representing lost tax revenue of approximately $100 billion
per year.66
Who Is at Risk with Self-Insurance?
End-users of health care are removed from the employer’s decision as to whether
or not a company will self-insure. In fact, employees rarely know if their health plan is a
self-insured plan. Licesensed insurance companies act as third party administrators for
many self-insured plans, giving the appearance that the licensed insurance company is
providing the insurance and not simply administering it. An employee cannot make a
fully informed decision, and given choice of health plans, an employee cannot know if
their health insurance is protected by certain regulations. Additionally, insurance
regulators investigating employee health plan complaints have no jurisdiction over self-
insured plans.67
A plan sponsor may be willing to expose their employee to a greater degree of
risk than the employee would have accepted had they been aware of the difference.
States may regulate the solvency of insurance companies, there are no federal standards
to do so for self-insuring firms. Polzer and Butler illustrate this danger in the case of an
65
Bodenheimer et al., 7, Institute of Medicine, 71.
66
Seifert et al., 9.
67
Polzer et al.

28. 27
employee in Oklahoma left with over $100,000 in medical bills after the employee’s firm
declared bankruptcy rather than pay the medical expenses. Studies suggest that at times
an employee’s health care costs can certainly become large enough to put many small
firms at risk68
Rising Costs and Recent Developments
As the institution of employer-based health care has matured, so has the
population. The financial benefits of off-setting wage increases by a preferential tax
system on health care plans decreases as the population ages, and the employers find
themselves covering the insurance for their retired workers.69
Moreover, health
premiums continue to rise, and in 2004, it was reported that premiums grew at double-
digit rates for the fourth consecutive year.70
Many employers are increasing employee cost sharing as a means of controlling
their total health care costs. In 2004, only 17 percent of large and medium-size
employers reported paying 100 percent of their employees’ premiums, down from 29
percent in 2000. The percent of the employees’ share is increasing as well, and in 2004,
41 percent of employers are considering an increase in cost-sharing percentage.71
Small
employers that offer health insurance have fewer cost-containment options available to
them, and therefore cutting or eliminating health benefits altogether becomes a
68
Polzer et al. See note n8.
69
Gottschalk, 110.
70
Kaiser Family Foundation, 1.
71
Fewer companies paid the full premium for family coverage, reported at 6 percent in 2004
compared with 11 percent in 2000, Freudenheim, 2005, C1, and Kaiser Family Foundation, 3.

29. 28
compelling option. Other options include reducing the size of the workforce through
layoffs or employing a workforce of part-time or contract workers who are not offered
benefits.72
Health Savings Accounts
One plan for cost-savings that is receiving considerable attention is the Health
Savings Accounts, or HSAs. Originally called Medical Savings Accounts, individuals
can save tax-deductible dollars in these accounts to pay for out-of-pocket medical
expenses. They exist in conjunction with high-deductible health insurance, intended to
cover catastrophic, or highly expensive procedures, rather than routine procedures that
can be expected and therefore should be part of an individual’s or family’s budget.
Employers can offer HSAs as an alternative to comprehensive coverage plans: the
employer can contribute yearly to the savings account owned by the employee to cover
medical expenses, including payments towards the deductible. The money in this
account would rollover year-to-year.73
Both employers and employees would see a cost savings in the smaller premium
for a high-deductible plan. The theory behind HSAs also suggests that the cost-savings
would increase because patients will use more restraint in seeking medical care if, by
paying for the service, they were aware of the actual cost of the care. The AMA,
conservative Republicans, and non-managed care private insurance companies support
HSAs. The National Business Group on Health, or NBGH—a coalition of 220 large
72
Institute of Medicine, 214.
73
Bodenheimer et al., 161-162.

30. 29
employers, primarily Fortune 500 companies that together provide health care coverage
for more than 40 million workers, retirees and their dependents—also supports the use of
HSAs; it has declared enhancements to HSAs as one of its key policy objectives for
2005.74
The tax deduction for HSAs extends to the self-employed and small businesses.
However, HSAs will most likely only benefit the healthier population; the sicker
population that retains private health insurance would inevitably see their premiums
increase even more as the healthier exit from the insurance group and no longer provide
subsidies for the higher-risk population. Considering that health expenses are
concentrated in a few, high-cost patients, there is no evidence that the high-deductible
consumer-driven plans will affect costs. It is unlikely that HSAs can help keep costs
down overall and will likely succeed only in shifting costs to the chronically ill. HSAs
are likely to cause an increase of underinsured: those individuals who are “covered” by a
high-deductible policy, but cannot afford the costs of their care before they reach the
deductible. Critics also see them as a tax shelter for the wealthy; pulling healthy out of
existing group plans and making the those traditional health insurance plans increasingly
less affordable.75
74
http://www.businessgrouphealth.org/healthcarepolicy/objectives.cfm accessed on August 12,
2013; http://www.businessgrouphealth.org/about/index.cfm accessed on April 6, 2005, and Wojcik.
75
Bodenheimer et al., 162, Enthoven, 239, and Seifert et al., 13.

31. 30
Conclusion
The employer-based system of health care provision grew in response to
legislation that gave unintended encouragement to the growth of benefit plans.
Employers were dealing with largely short-term interests during a time of economic
growth. However, with the uncertainty of today’s economy, the aging population, and
the increasing costs of health care, the once short-term solutions are beginning to lose
their relevance; many Americans realize the risks involved in tying their health care to
the generosity of their employers.
Mandates will not solve this problem either. The Clinton plan did not fail simply
because of the opposition of unified interest groups. Rather, by attempting to preserve
the benefits of the systems, the Clinton plan brought its complexities and contradictions
to the surface. It became impossible to formally legislate the partially government
subsidized, somewhat private, somewhat public insurance system, without creating more
dilemmas than already existed. Today, the climate for health care reform has an
ingredient that the past reform movements did not: close to all parties agree that the
system is largely unsustainable over the long-term. However, many also agree that
voluntary employer-based system has one advantage over all the proposed reforms: it
already exists. It is a shame to defer the health care needs of Americans to an accidental
status quo.

32. 31
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