Health Insurance: Availability and Adequacy for Small Businesses

Published by the Government Accountability Office on 1990-06-05.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                   United    States   General   Accounting     Office

GAO                Testimony

 For Release        HEALTH INSURANCE:
 on Delivery        Availability          and   Adequacy
 Expected at        for     Small     Businesses
 1O:OO a.m. EDT
 June 5, 1990

                    Statement    of
                    Mark V. Nadel, Associate                  Director
                    for National    and Public               Health
                    Human Resources Division
                   Before the
                   Subcommittee on Antitrust,
                     Monopolies and Business                   Rights
                   Committee on the Judiciary
                   U.S. Senate

                                                                         GAO Form 160 (12.W   j
  Small    businesses      are having an increasingly      difficult        time
  offering     health    insurance   which meets the needs of their
  employees.       This is the result      of rapidly   increasing        costs             of
  health    care and changes in the insurance          market        especially              the
  use of strict       underwriting    standards   by insurer;.
 About half of small businesses         with less than ten employees do not
 offer     health insurance    coverage to their  employees    with cost and
 insufficient     profits   being the two most important    l‘easons cited for
 not doing so.
 Compared with larger               companies,    small ones have been particularly
 hard hit by several              closely   related    factors, including:
          --   the inability   of small employers     to spread risk of
               substantial   health care costs over a large number of
               employees and the consequent    greater     chance that just one
               or two employees with serious     illnesses    will  lead to huge
               premium increases,
          --   the increase     in the use of insurance               premiums that are
               based on the experience       of individual              companies
                (experience   rating)  rather   than the             broader   community
               (community   rating),
          --   competition     among insurers   for businesses   that present
               lower risk,     and consequent   higher  costs for businesses
               with worse     experience,   and
          --   rapid   turnover      of   firms    insured    by an insurance          company.
 Thus, insurance          pricing    mechanisms constitute              a major problem for
  small business.           This market is characterized                by businesses
  frequently        changing    or otherwise      leaving       their     insurance
 companies.          While many small      businesses         simply go out of business,
 others      periodically       choose new insurers           who offer         lower rates.
 This competition           may eventually      exclude       some employees,             however
.because insurers           may use medical       underwriting          criteria        to exclude
 employees with preexisting              conditions        (including        illnesses
 developed        under coverage of the previous                insurer).          Culling    out
 less healthy          employees makes the initial             costs for a small business
 policy      relatively      low.    From the second year onward, however,                        the
 firm's     employees begin to develop              illnesses        that are covered,
 leading      to higher      costs for the insurers            and higher         premiums,       and
 shopping       for a new insurance        company again.              The net result         is a
 reduction        in the effective      amount of health             insurance       coverage.
Mr.      Chairman         and Members of the                            Subcommittee:

          I am pleased              to be here               today         to discuss             problems           which         small
business          have     in providing                    health         insurance            to their        employees.                  On
May 22,       1990,        we issued             a report                addressing            restrictive             changes            in
employer-sponsored                      health            insurance          plans       by both           small       and large
firms.1           Today's          focus        is        on small         business,            and we will             discuss
the     problems          that      employees               of small             businesses          face      in obtaining
adequate          and affordable                 health            insurance            coverage.             While      till       firms
are     having       problems            with        rapidly            rising       health        care       costs,         our
findings          indicate          that        the        workings         of the         small         business           insurance
market       create        unique          problems               for     small      firms        that       exacerbate             the
impact       of rising            costs         affecting               firms      of    all      sizes.           In group
health       insurance,             actuaries               consider             any group         with       less      than        25
employees          to be small.

         As the       Subcommittee                   is     aware,         health        care      costs       have been
increasing          rapidly.               These          increases              in health         costs       have      led       to
more than          an eight-fold                 increase               in business             health        spending
between       1970 and 1987.                     Such rising                health        costs          have adversely
impacted          firms      of all         sizes;                But small          firms       and their            employees
have been particularly                          hard       hit.          A National             Association            of
Manufacturers              survey          found          that      during         1988 health             care      costs         for
firms      with     less         than      25 employees                  increased             by 33 percent--a                 rate

lHealth  Insurance:                      Cost Increases                    Lead to        Coverase            Limitations
and Cost Shifting                       (GAO/HRD-9.6-68,                   May 22,        1990).
of      increase                  one and a half                    times         the      rate        experienced               by the
nation's                   largest           firms.

           Probably                   the     most            important           effect          of    rising           costs         is    the
inability                   of a substantial                        number of employees                            of    small         firms        to
obtain           group             health           insurance.                The smaller                    the     firm,       the        less
likely           it         is     to offer              health          insurance.                Almost            half     of the
working               uninsured               are        employed           by businesses                     with       fewer       than          25
employees.                       of    the         8.2        million       uninsured              private              wage and salary
workers               in     1984,           3.9     million             were employed                  by a firm             with          fewer
than      25 employees.

Erosion           of the               Small         Business             Health           Insurance               Market

          Problems                    with     the        cost          and availability                      of     insurance              are     in
large          part          consequences                      of the       nature          of the            small         business           health

insurance                  market.             A confluence                  of     factors             is     leading           to the
erosion           of the               health            insurance           market          for        small           employers.                These
factors           include:

          --      the            inability               to     spread       risk       over           a large           number        of

          --     the             decline           of the          availability               of community                    rated         health
                  insurance                  products,

           --    competition                among insurers                   to     offer             coverage        only      to     the
                 best      risks,

           --    medical         underwriting                practices,                  and

           --    rapid      turnover              of    firms      insured               by an insurance                      company.

          Insurance             is used to              spread         risk.             It      is     probable         that        in a
sizable          population,               only        a small         percent                of the         people      will        incur
substantial              health        care        costs.          The losses                   of the          few with         high
health          care     costs        are     shared        among many,                       as covered             individuals
(or     their          employers)           make regular                payments                 into        an insurance             fund
from     which          payments           can be made.                 Small            firms,          because         they        are
insuring          only      a few individuals,                         are        less         able      to take         advantage
of this          pooling         of    risks.            Therefore,                when insurance                     premiums          are
based       on the         experience              of    individual                small          companies,             those
companies          with         even a single               employee               with         high         costs     can be
adversely          affected            because           of their            small             risk      pool.

         In the          past       this     dilemma             has been avoided                        through         a system
known as community                     rating--          a mechanism                for         spreading             risks      more
broadly.           Under         community              rating         the        premium             is based         on the
average         cost      of actual             or anticipated                     health             care     used by all
subscribers              in a particular                  geographic                area,             industry,         or other
broad      grouping             and does not              vary         for        subscribers                 (individual
companies)             within         each grouping.                    Therefore,                    an individual              firm's

 premium        generally          is        not     further              adjusted         for     such variables              as
 its     own claims           experience              on the              health       status        of     individual
 workers.            Blue     Cross          plans      in most             states         have traditionally
 offered       community           rated           plans       to small              firms.

           Greater        competition                in the           insurance            marketplace            has led          to
the      erosion        of community                 rating.               Commercial            insurers         were     able         to
select        from      the     community             pool       small           businesses           which       were better
risks       and offer           them lower              rates,             thereby         raising         the    rates      for        the
higher        risk      firms      remaining               in the           pool.          As commercial             insurance
companies            continued          to     siphon          off         the     firms      with        the    lowest
expected         health         costs,         the     ability              to     spread        risks       in community
rated      plans       diminished.                   As a result,                  community          rated       health
insurance            products       became less                 available.                  Even Blue            Cross/Blue
Shield       plans       have had to                 reduce          the     extent         of community             rated
health        insurance.

Restrictive            Underwritins                 Practices

         Small        businesses             are      currently              in a market             where        some

insurers         are    attempting                 to move costly                   industries,             firms     or
individuals            out      of their            pool       through             restrictive             underwriting
practices.*             Medical          underwriting                     often       results        in the         exclusions
of     some employees             from        coverage               if    they       have preexisting

*Underwriting               generally  refers                   to insurance  companies'    criteria
and decisions               as to which risks                     to accept or exclude   from
conditions             such as cancer,                         diabetes,           heart         disease          or other                high
cost       illnesses.                   In some cases                such         individuals             may be denied                     any
coverage,             and in other                    cases       only      the     specific          preexisting
condition             is    excluded.                   This      underwriting              may also             limit          the
coverage          available                 to spouses             and dependents                  of the             employee.

         Another            underwriting                   practice           employed           by some insurers                          of
small         firms        is    to exclude                selected           types        of businesses.                       Small
firms         in entire            industries                  sometimes           are     excluded           from          coverage              by
insurers.              While          the      list        of excluded              industries             varies              by

insurer,          there          is     considerable                 overlap.              Among the             many           types            of
businesses             that        various             insurers           exclude          are     logging,              mining,
roofing,          taverns,              hair          stylists,           and medical              offices.

         Some insurers                   do not            cover      a number             of    industries                 where         the
risk     of     illness            or injury               appears         to be greater                  than         average,             such
as logging             or roofing.                     With       high-risk           occupations,                    the      concern            is
not     only     with           health         care        costs      but      also        the     legal         expense             of
determining                whether          workers'              compensation              or health                 insurance             is        to
be the         primary           payer.           For       instance,             some insurers               do not                cover

         --     physicians               or lawyers                because          they        believe          it      is     too
                expensive               to deal           with       fraud,         abuse,         and litigation                     for
                small           firms       in these              areas:
         --     entertainment                   or sports             industries                because       of the
                perceived               high      risk         of drug         abuse        treatment                 costs;         and

               --     barbers,       beauticians,               and decorators                    because          of their
                      assumptions          about        the     higher         risk           of AIDS and sexually
                      transmitted          disease         generally.

              Even when a firm                and its           workers            have health             insurance,             they
may still                be affected          by their           insurance                   company's       underwriting
practices.                 Policies          are written              for     a set            time      and at the             end of
that          term       some insurance              companies              may     subject            covered         individuals
to medical                underwriting              criteria.               This        practice,          known as "renewal
underwriting"                    can result          in exclusion                  of coverage             for     any person
who has developed                        an expensive            medical            condition             while        he or she is

Turnover,               Pricins,          and Underwritinq

              Because          of the      factors        discussed               above,         workers          in    small
businesses               may face          particular            problems               if     they      change        employers
or      if     their       employers          change          insurance            companies--a                  frequent
occurrence.                    Based on our           discussions                 with         several      companies            who
provide               insurance       to small          businesses,                it        appears       that        nearly      a
third          of the          insured      firms       leave         these        insurance              companies         or are
not          renewed       each year.

              First      year      costs      for     a small          business               policy       are     considerably
lower          than      the      costs     for      subsequent             years            because       of medical
underwriting                and preexisting                   condition            exclusions.                In the        second

and subsequent                     years        some preexisting                        condition                 exclusions                expire
and the           covered           population                begins            to develop                new conditions                     leading
to higher             costs.             Higher          costs           generate             the     need for             rising
premiums.               In the           face         of these            higher             premiums,             many small
businesses              respond               by seeking               a new insurer                  who will             offer            them a
lower       first          year         rate.          Problems               for      employees             will         arise        if     they
had a serious                    illness           or even a pregnancy                          which             began under                the
lapsing           insurance              contract.                These employees                         may well           find
themselves              excluded               from     necessary                   coverage          under         the     new insurance

          Similar           problems               occur         for      workers             who are             changing            jobs       or
have      recently               lost      their        job.            Providing              transitional                 coverage               is
another        important                 issue         for       small         business.               They have higher
labor       force          turnover             rates         and longer                waiting             periods         before
health       coverage               begins          than         larger             firms      do.          Further,             at
termination                of employment                     small        firm        employees              usually             do not        have
the      option        of continuing                    their           health          insurance                 coverage            at group
rates.         Current              laws        mandate           this         option          only         for     firms         with        20      or
more employees.                         For     firms         with        20 or more employees,                             the
Consolidated                Omnibus             Budget         Reconciliation                       Act      of     1985 (COBRA)
requires            that     employers                offering                health         insurance              benefits             offer
employees            separating                 from       the         firm         (other      than         for     gross
misconduct)                the     option           of continuing                     health          coverage             for        up to        18
months.           For       such employees                     electing               this      option,             the     premium            will
be no higher                than         102 percent                 of the           group         rate,          payable            by the

employee.                   The Omnibus               Budget       Reconciliation                   Act     of      1989 extends
the     period              for         continuing        group         health           insurance          coverage          for      the
disabled              for         an additional              12 months.                  During       the     period,         the
premium          will             be no higher            than       150 percent               of the         group     rate,
payable          by the                 employee.

Prooosals              for         Addressins            Problems

          Insurance                     experts       and groups             concerned            with      improving          access
to     insurance                  for     employees          of    small          firms       suggested          a number of
options          to     lessen              problems         in the          small        business          health      insurance
market.           These                 include:

          --     encouraging                   or requiring                 greater        use of community                   rating,
          --     eliminating                   pre-existing                 condition          clauses,
          --     encouraging                   portability              of health             insurance          benefits,
          --     guaranteeing                      renewability              of    insurance             policies       for      all
                 covered                 individuals,             and
          --     providing                  subsidies           to high           risk     pools.

          The first                 and second            options,            setting          rates        on a community-
wide      basis         and eliminating                      pre-existing                 condition          clauses,          were
among the             insurance                market        reform          recommendations                 made to the
Congress          by the                U.S.       Bipartisan           Commission             on Comprehensive                 Health
Care      (the        Pepper              Commission)             in March            1990.        The Pepper           Commission
further          recommended                   that     there       be no denial                  of coverage           for     any

 individual             in a small          group        and that           there         be guaranteed                 acceptance
 of all         groups      wishing         to     purchase           insurance.

          The third,             fourth      and fifth              options,             encouraging            portability
of benefits,             guaranteeing               renewability,                  and developing                  mechanisms
to     fund      high     risk     pools,         were among approaches                          recommended               by the
Health          Insurance         Association             of America               in     February            1990.

          There      have been some attempts                              to deal        with      the        problems           in
the     small       business         market         by state              government            creation          of     assigned

risk      pools      and industry                group        creation         of multiple               employer           welfare

arrangements              (MEWAS)~.              However,           these      have met with                   mixed       success.
Because         of developing               financial           problems            in        some MEWAs and               concerns

about       fraud       and abuse           in this        market,           the        National         Association                  of
Insurance           Commissioners                last    month called                   for     increased           scrutiny               of


          In conclusion,              our        work    has indicated                   that      in many instances
workers         in small         businesses             are     uninsured               or underinsured                  due to
financial           pressures         on their           employers             compounded             by the            nature         of

the     small       business        health          insurance             market.             While      a number           of

options         have been proposed,                     after        much study               there      is     still       no
consensus           and the        nation         has not           yet     embraced            a solution              to this

3These arrangements are sometimes referred                                               to as multiple                  employer
trusts,  or METS. Multiple  employer welfare                                               arrangements,                 however,
is the term defined in federal   law.
        Mr.   Chairman,   this   concludes        my statement.   I would   be happy

to answer      any questions     that   you or members of the       Committee   may