This post is part of a blog series on the history of the U.S. health insurance industry. This series has been adapted from the Zane Benefits white paper, The Inevitable End of Small Business Health Insurance. To access Part 1 of this blog series, click here.
The Beginning of Employer-Based Health Insurance
As we discussed in Part 1 of this series, employer-based health insurance was created in the aftermath of World War II.
As a concession to labor groups, the federal government exempted employer-based health benefits from income tax and wage controls. This in turn drove enormous demand for employer-based health insurance.
The potential 2-for-1 tax advantage (depending on the income tax bracket of the employee) for employer-based health benefits shifted the market away from health insurance purchased by individuals directly.
Employer-Based Health Insurance and an Attempt to Stem the Bleeding
The employer-based health insurance market began to unravel in the late 1980s and early 1990s as many insurers only wanted to insure the healthiest groups. In the 1990s, most states adopted new legislation called the National Association of Insurance Commissioners’ (NAIC) "Small Employer Health Insurance Availability" Model Act in an attempt to address the growing market instability.
The NAIC act made certain plans to small employers “Guarantee Issue.” However, small employers could still be turned down if they did not meet minimum participation requirements and/or minimum employer-contribution-to-premium requirements set by the insurer.
While the NAIC act did make health insurance more accessible to small businesses, it did not address affordability. Facing double-digit growth in health insurance premiums, many small employers either ceased offering health benefits or redesigned the plans with higher cost-sharing by employees.
These annual benefit reductions and increased cost-sharing by employees inevitably led to an on-going version of adverse selection – a perpetual process referred to as the small employer-based health insurance death spiral.
The Employer-Based Health Insurance Death Spiral
The death spiral starts when an employee’s cost to participate in the employer plan exceeds the employee’s willingness to pay.
When this happens, the healthiest employees begin to drop off the employer plan in favor of individual policies. This causes the remaining small employer risk pool to become “sicker”, resulting in higher insurance premiums on renewal the following year.
Then, the process repeats. Again, the employer reduces benefits to maintain costs, more healthy employees drop off, and the rate goes up the following year.
This death spiral perpetuates until the small business either: (1) cancels the plan; or (2) is unable to meet the minimum contribution requirements or minimum participation requirements set by the insurer, and the plan is canceled by the insurer.
Rise of the Individual Health Insurance Market
As the death spiral of employer-based health insurance continued into the 2000s, the individual market reemerged as a viable solution -- and, as we will discuss in the next part of this series, innovative businesses (like Zane Benefits) were formed to service this growing market.