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Market Failure in Small Group Health Insurance

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  • David Cutler

Abstract

Typically, health insurance premiums depend at least in part on the previous costs of the insuring firm, a factor termed 'experience rating'. This link between health status and future premiums raises concerns of market failure, since it limits the ability of firms to insure the price at which they can purchase insurance in future years. This paper examines the economic factors influencing experience rating. The first part of the paper demonstrates that experience rating is quantitatively important. Premiums at the 90th percentile of the distribution are 2 1/2 times greater than premiums at the 10th percentile of the distribution, and this difference does not appear to be due to the generosity of benefits or the demographic composition of the firm. The second part of the paper then discusses explanations for the prevalence of community rating, including inability to write long-term contracts, lack of demand from firms with below average costs, and public policies that provide subsidies to the uninsured. The last part of the paper examines these predictions empirically. I find evidence that firms with high-wage employees and low turnover have less premium variability than firms with low-wage employees or high turnover, but no evidence that public policies affect premium variability.

Suggested Citation

  • David Cutler, 1994. "Market Failure in Small Group Health Insurance," NBER Working Papers 4879, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:4879 Note: HC
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    File URL: http://www.nber.org/papers/w4879.pdf
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    References listed on IDEAS

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    1. David M. Cutler, 1994. "A Guide to Health Care Reform," Journal of Economic Perspectives, American Economic Association, vol. 8(3), pages 13-29, Summer.
    2. David M. Cutler, 1993. "Why Doesn't the Market Fully Insure Long-Term Care?," NBER Working Papers 4301, National Bureau of Economic Research, Inc.
    3. Manning, Willard G. & Marquis, M. Susan, 1996. "Health insurance: The tradeoff between risk pooling and moral hazard," Journal of Health Economics, Elsevier, vol. 15(5), pages 609-639, October.
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    Citations

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    Cited by:

    1. David M. Cutler, 1994. "A Guide to Health Care Reform," Journal of Economic Perspectives, American Economic Association, vol. 8(3), pages 13-29, Summer.
    2. Jonathan Gruber & Brigitte C. Madrian, 2002. "Health Insurance, Labor Supply, and Job Mobility: A Critical Review of the Literature," JCPR Working Papers 255, Northwestern University/University of Chicago Joint Center for Poverty Research.
    3. Kanika Kapur & José J. Escarce & M. Susan Marquis & Kosali I. Simon, 2005. "Where do the sick go? Health insurance and employment in small and large firms," Open Access publications 10197/259, School of Economics, University College Dublin.
    4. David Cutler & Jonathan Gruber, 2001. "Health Policy in the Clinton Era: Once Bitten, Twice Shy," NBER Working Papers 8455, National Bureau of Economic Research, Inc.
    5. Kanika Kapur & Pinar Karaca‐Mandic & Susan M. Gates & Brent Fulton, 2012. "Do Small‐Group Health Insurance Regulations Influence Small Business Size?," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 79(1), pages 231-260, March.
    6. Jonathan Gruber, 1998. "Health Insurance and the Labor Market," NBER Working Papers 6762, National Bureau of Economic Research, Inc.
    7. Stéphane Jacobzone, 1997. "Systèmes mixtes d'assurance maladie, équité, gestion du risque et maîtrise des coûts," Économie et Prévision, Programme National Persée, vol. 129(3), pages 189-205.
    8. Sapelli, Claudio & Vial, Bernardita, 2003. "Self-selection and moral hazard in Chilean health insurance," Journal of Health Economics, Elsevier, vol. 22(3), pages 459-476, May.
    9. Alan C. Monheit & Thomas M. Selden, 2000. "Cross-subsidization in the market for employment-related health insurance," Health Economics, John Wiley & Sons, Ltd., vol. 9(8), pages 699-714.
    10. Miguel Gouveia, 1996. "The public sector and health care," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 3(3), pages 329-349, July.
    11. David M. Cutler, 1996. "Public Policy for Health Care," NBER Working Papers 5591, National Bureau of Economic Research, Inc.
    12. Edlin, Aaron S, 1996. "Cadillac Contracts and Up-Front Payments: Efficient Investment under Expectation Damages," Journal of Law, Economics, and Organization, Oxford University Press, vol. 12(1), pages 98-118, April.
    13. repec:eee:labchp:v:3:y:1999:i:pc:p:3309-3416 is not listed on IDEAS
    14. Kanika Kapur & José J. Escarce & M Susan Marquis & Kosali I. Simon, 2008. "Where Do The Sick Go? Health Insurance and Employment in Small and Large Firms," Southern Economic Journal, Southern Economic Association, vol. 74(3), pages 644-664, January.
    15. Laurence C. Baker & Kenneth S. Corts, 1995. "The Effects of HMOs on Conventional Insurance Premiums: Theory and Evidence," NBER Working Papers 5356, National Bureau of Economic Research, Inc.
    16. Rahkovsky, Ilya, 2010. "Exclusive contracts in health insurance," MPRA Paper 27473, University Library of Munich, Germany.
    17. Chu-Shiu Li & Chwen-Chi Liu & Yu-Chen Kuo & Chen-Sheng Yang, 2013. "Health insurance provision and labor contracts for small firms," Small Business Economics, Springer, vol. 40(2), pages 325-334, February.

    More about this item

    JEL classification:

    • I18 - Health, Education, and Welfare - - Health - - - Government Policy; Regulation; Public Health

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