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Donald A. Young and Thomas F. Wildsmith • Thomas R. Hefty

H E A L T H  A F F A I R S : P E R S P E C T I V E  
W E B  E X C L U S I V E     

17 April 2002
   
   

Individual Versus Employer Insurance Markets:
Digging Deeper Into The Differences

A voluntary individual insurance market is not an employee benefit program
and should not be expected to look like one.

Donald A. Young and Thomas F. Wildsmith


The paper by Jon Gabel and colleagues criticizes the individual health insurance market for providing coverage that is less generous than that of employer-sponsored health plans. Others have suggested that the employment-based system results in overinsurance. But there is no simple answer to the question, "How much coverage is enough?" Moreover, employer-sponsored plans are not the standard by which to measure the appropriate level of coverage for a consumer to purchase in a different market: A voluntary individual insurance market is not an employee benefit program and should not be expected to look like one.

In the employment-based system, workers are insulated from the cost of coverage because of the employer subsidy, which makes participation more attractive. In the individual insurance market, however, there is no employer subsidy; for most, there is not even a tax preference-premiums are paid with pretax dollars. In consequence, the consumer is price- sensitive, with each individual in that market making a direct and personal decision about the most appropriate balance to strike between coverage and cost.

Purchasers in the individual market may well be selecting coverage that is less generous than that provided by employers, but not because more-comprehensive coverage is not available. Nor are these consumers irrational: Given the cost differential between individual and group health insurance, purchasers in the two markets are striking a different balance between retaining and insuring risk.

The study addresses a critical issue: How does individual health insurance coverage differ from that provided by employers? In particular, its survey of what is available on the Internet contains valuable information on the range of available individual health insurance products. It also shows how difficult it can be to draw valid comparisons between the two markets. Unfortunately, because of data limitations (which the authors acknowledge), the study does not tell us which products consumers actually choose to purchase, nor does it explain why consumers in the individual market might make purchasing decisions that are different from those of employee benefit plan sponsors.

Methodological limitations. As the authors correctly note, the primary limitation of the study is the lack of information about how many consumers purchase particular policies in the individual market. In an attempt to overcome this limitation, the authors assume that all products are equally popular, an unusual assumption to make in any consumer market. (Few of us would assume that all breakfast cereals, or all makes of automobile, are equally popular.)

In the case of individual health insurance, strong evidence suggests that all products are not equally popular. A study of 20,000 policies purchased through eHealthInsurance.com recently found that 75 percent were PPO products, 16 percent were HMO products, and only 5 percent were indemnity plans. POS and MSA products accounted for the remaining 3 percent.¹ Others have found that the individual health insurance market is highly concentrated; in each state only a few insurers account for most of the policies sold.² Clearly, some products are much more popular than others. Rather than "simulated extrapolations," the results of this study should be seen for what they are: a sample of the products available.

Unfortunately, this limitation invalidates all of the averages calculated for the individual market. For instance, while the authors report a wide range of "actuarial values" among the individual products, the absence of information on which products people are actually buying makes it impossible to determine the mean value for the individual market. Calculating such a mean without enrollment information is the equivalent of estimating what the typical television viewer watches by scanning through a program guide and "averaging" a random sample of the program listings.

The data on the individual health insurance market are also limited to a single, relatively new distribution channel. If Internet purchasers are younger and more price-conscious than are those using such conventional channels as agents and brokers, and if the products offered reflect their preferences, the results will likely understate the amount of coverage the average individual policy provides. Evidence does suggest that Internet purchasers are younger. In 1996 the U.S. General Accounting Office found that the median age for individual purchasers was thirty-five, while those buying individual coverage through eHealthInsurance.com are thirty, on average.³

Interpretive limitations. The most serious interpretive limitation of the study is the assumption that the percentage of medical expenses reimbursed measures the "performance" of an insurance policy, rather than the amount of financial protection consumers choose to buy. Determining the appropriate amount of coverage to purchase is a risk-management decision. (An automobile policy with a $200 deductible for collision coverage does not necessarily "perform" better than one with a $500 deductible; the same is true of medical expense insurance.)

The two policy features critical to catastrophic protection are the out-of-pocket limit and the maximum benefit level. In their discussion of catastrophic protection, the authors focus on the top 25 percent of users, who have average expenses falling below many typical out-of-pocket limits. This is not an adequate test of protection against truly catastrophic expenses or of the financial impact of different out-of-pocket limits.

In addition, their calculation includes all medical expenses, not just those above a certain threshold. Purchasers must balance the degree of up-front risk they are willing to bear against the premiums they are willing to pay. Paying a higher percentage of routine costs does not lessen a policy's catastrophic protection. If routine expenses are to be included in a measure of catastrophic protection, premiums should be included also. By failing to include premiums, this study fails to recognize the trade-off between upfront protection and the cost of coverage. The key fact is that both individually purchased and employer-sponsored plans include out-of-pocket limits, and those limits are chosen by purchasers.

There are many reasons that an individual purchaser might select less coverage than is typical among employee benefit plans. The authors allude to one of these: that administrative expenses are much higher for individually purchased insurance. Since each dollar of health insurance protection costs more in the individual market, it is not surprising that consumers in that market buy less of it. For many consumers, differences in the tax treatment between individually purchased and employer-provided coverage will be an additional factor.

Finally, the authors find not only low-cost plans available in the individual market, but also plans with higher "actuarial values" than those typical in the group market. Any significant tax credit would effectively reduce the cost of health insurance, and many consumers would then likely buy more coverage than they do now. Whether benefits in the individual market would ever become as generous as those offered by employers would depend on the size of the credit and the value consumers placed on the coverage.

NOTES

1. V. Patel, "Analysis of National Sales Data of Individual and Family Health Insurance," eHealthInsurance.com (June 2001).
2. D.J. Chollet, A.M. Kirk, and M.E. Chow, Mapping State Health Insurance Markets: Structure and Change in the States' Group and Individual Health Insurance Markets, 1995-1997 (Washington: Academy for Health Services Research and Health Policy, December 2000).
3. US General Accounting Office, Private Health Insurance: Millions Relying on Individual Market Face Cost and Coverage Trade-Offs, Pub. no. GAO/HEHS-97-8 (Washington: GAO, November 1996); and Patel, "Analysis of National Sales Data."

Donald Young is president and Thomas Wildsmith a policy research actuary at the Health Insurance Association of America in Washington, D.C.

©2002 Project HOPE–The People-to-People Health Foundation, Inc.