Association for Public Policy Analysis & Management

The Affordable Care Act (ACA) introduces strong community rating reforms in the small group market and increases the number of firms subject to these regulations. However, firms can avoid these regulations by opting to self-insure their health benefits. Because this self-insurance option is likely to be more attractive to firms with relatively healthier workers, many policymakers and analysts have raised concern about adverse selection into the fully-insured small group market, resulting in higher premiums and fewer choices. However, despite this level of speculation and concern, very little is actually known about predictors of self-insurance among smaller firms and, specifically, the effects of rating regulations on firm self-insurance.

We provide empirical evidence on the relationship between small group market community rating and firm self-insurance by exploiting cross-state variation in small group market community rating laws prior to the ACA. We hypothesize that firms with relatively healthier workers will be more likely to self-insure when they face more strongly community rated premiums, due to the fact that they stand to benefit more from avoiding these premiums that are pooled with firms with relatively sicker workers. We analyze data from a restricted-use version of the nationally-representative KFF/HRET Employer Health Benefits Survey for 2008 through 2012. Because these data do not include information on the health status of workers at the firm, we use data from the MEPS-HC to construct industry-level measures of average relative health risk, based on pre-existing chronic conditions, and merge these industry-level measures to the firm-level data. We run firm-level probit models to test for differences in the effect of health risk on self-insurance across states with and without industry-related community rating for regulated small group firms, using slightly larger firms as an unregulated control group.

We find that firms in lower risk industries subject to community rated premiums have a predicted probability of self-insurance that is 7.8 percentage points higher than similar firms facing more risk-rated premiums, while firms in higher risk industries subject to community rated premiums have a predicted probability of self-insurance that is 16.8 percentage points lower than similar firms facing more risk-rated premiums. These findings are robust to alternative specifications and definitions of health risk and community rating.

Consistent with our hypothesis, we find evidence that relatively healthier firms are more likely to self-insure when they face more strongly community rated premiums. These findings suggest that concern about the ACA’s community rating reforms leading to adverse selection into the small group market via selective self-insurance of firms with relatively healthier workers are indeed warranted. To the extent that state and federal officials wish to maintain robust participation in the small group market and achieve cross-subsidization of premiums from lower risk to higher risk firms, policy actions such as stricter regulation of the sale of low-attachment stop loss policies to small firms and/or regulating re-entry of firms from the self-insured market back into the fully-insured community rated market should be considered.