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and group policies to about 164 million Americans who have private health insurance coverage.9 This growth of insurance has had both positive and negative effects on the performance and efficiency of the health care sector. A partial description of some of these effects follows.10
Health insurance has provided financial protection to a majority of the American work force and their dependents. The special tax treatment of health insurance has increased both the absolute number of people covered and has extended the range of medical services provided in a typical policy.
This insurance coverage has been provided by a relatively large number of diversified firms, which has increased the choices of types of coverage and the efficiency and adaptability of the insurance industry.
The business firm has provided a convenient method of spreading risk and efficiencies in the administration of the insurance plan. From the health insurance company's point of view, it is cheaper to insure an employer group than a similar number of individual policies for three reasons: (1) there are economies of scale in the administration of a group of employees, resulting in lower loading factors; (2) on average, working individuals are younger and healthier than individuals who are not working,11 and (3) if the group is large enough, the insurer can be relatively sure that the employees did not accept the job to obtain health insurance (the probability is low that the group has attracted individuals who are sicker than average).12
Because individuals with health insurance use more health care services than uninsured individuals, the special tax subsidies for employer-based health insurance have increased the demand for health care above the amount that would have existed without the subsidy. As research by Martin Feldstein and others has shown, this increase in the demand for health care resulted in higher health care prices and higher rates of growth in health care expenditures than would have existed without the subsidies.13
Tax policy has also contributed to the health cost problem by reducing the extent of consumer cost sharing in health insurance plans. During the period of a rapidly increasing demand for health insurance, health insurance companies competed for business by offering policies with lower deductibles and copayments. Such policies were more expensive than policies with more cost sharing, but because the extra cost was partially subsidized by the tax exclusion, the average amount of cost sharing declined in health insurance policies for most of the 1960s, 1970s, and into the 1980s. Since the mid-1980s, there has been some retrenchment on cost sharing as employers have attempted to control the rapidly rising cost of their plans. Because the purpose of cost sharing is to control the insurance-induced consumption
9
Statistical Abstract of the United States, 1996, Table 767; EBRI, Sources of Health Insurance and Characteristics of the Uninsured, Issue Brief No. 179, November 1996. Not all employer-based insurance coverage is provided through insurance companies because the current ERISA law gives firms strong incentives to self insure, that is, instead of paying premiums to an insurance company, they set aside funds to directly pay the medical costs occurred by their employees and their dependents. Some firms who self insure may contract with insurance companies to provide administrative services for their plan without paying an insurance company to assume risk.
10
For more on the effects of insurance, see Mark V. Pauly, ''Taxation, Health Insurance, and Market Failure in the Medical Economy," Journal of Economic Literature, vol. 24 (June 1985), pp. 629-675; Field and Shapiro, Employment and Health Benefits.
11
Self-employed individuals may be just as healthy as individuals working for an employer, but the cost of determining their health status is greater. In addition, insurance companies face higher risks to the extent that the self-employed and small employers have incentives to include relatively unhealthy dependents in their group policies.
12
The health insurance industry has been accused of "redlining," that is refusing to cover some employers in certain locations or occupations where they perceive that the employer group may have attracted employees with a high risk of having an expensive disease (e.g., AIDS) or who may engage in work activities (e.g., a tree surgeon) with a high risk of injury. Almost all states have some regulations that attempt to control unfair discrimination.
13
Martin Feldstein, Hospital Costs and Health Insurance. (Cambridge, Massachusetts: Harvard University Press, 1981).
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