Bell Issue Brief

Rate regulation in the small-group health insurance market

By Robin Baker, Ph.D.

May 21, 2007

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Executive summary
Introduction
Section 1. States, small employer insurance and rate regulation
Section 2. Do community or adjusted community rates increase premium cost more than band rates?
Section 3. The health care marketplace and health care premiums
Conclusion
Appendix A: Methodology
Appendix B: Number of insurers by state and percent change, 1997-2001, for the small-group market
End notes

Executive summary

The Colorado General Assembly passed legislation in 2007 to eliminate health status and claims experience as case characteristics that small-group insurers could use to set health insurance premium rates. This legislation still allows insurers to set rates based on other characteristics, such as age, family composition, type of industry, tobacco use and geography. The bill, HB 07-1355, is currently awaiting the governor’s signature. It passed with narrow majorities in each chamber. (Editor's note: Gov. Ritter signed the bill on June 1, 2007.)

At the heart of the debate is how best to regulate health insurance rates for the small-group market so rates are affordable to small businesses and their employees while providing enough incentive for insurers to offer policies to this market.

Regulation of private insurance companies is part of the state’s basic responsibility to ensure that health plans are adequate, providers are qualified, consumers are protected and insurers operate in the public interest.

Other studies and the Bell Policy Center’s analysis of health insurance regulation in other states shows that small-group rate regulations have minimal impact on premium costs and the willingness of insurers to serve this market. This is largely because small-group market rate regulations do not directly address major health care cost drivers, such as an aging population or increased use of advanced technologies and procedures. Rate regulations more directly address features such as benefit package standards, insurer profit margins, and limits on what insurers can charge when purchasing an insurance policy.

Rate regulations can provide a structure for evening premium costs and protecting policyholders from excessive medical costs by encouraging the pooling or merging of health risks of many workers and their families.

State regulations can protect small businesses and workers from inequitable price fluctuations. For instance, when insurers are prohibited from setting rates on case characteristics such as health status or claims experience, the health misfortunes of one worker or a family member will not financially penalize co-workers.

Rate regulation also establishes a base for expanding health coverage. By removing health status and claims experience from Colorado’s small group market, the state better aligns itself for state health reform efforts and possibly federal reform efforts. Consider that in 2007, three of the four proposals being examined at the federal level to reform the U.S. health insurance system include pooling health risks into larger groups in order to equalize premium costs, regardless of health risk.

HB 07-1355 is a critical building block in the state’s efforts to cover more individuals, reduce volatile small-group premium costs and move the state toward comprehensive health care reform. House Bill 07-1355 is an important first step toward helping small businesses provide affordable health insurance coverage to workers.

Key findings from our study include:

• Identifying direct correlations between state rate regulations and premium costs is nearly impossible because so many factors exert influence on the small group market.
  
• Colorado’s rate regulations did not have a unique impact on total average premium costs and the small group market. Rather, Colorado’s experience mirrored that of other states and the nation as a whole through the 1990s and 2000s.
  
• Among the states we studied, the average total costs of premiums have increased in every state regardless of the type of rate regulations they used between 2000 and 2004. Fluctuations in premium costs reflect changes in the health care marketplace rather than changes in the type of state rate regulations—a pattern that holds for the nation as a whole.
  
• Overall, studies show that price fluctuations and the number of insurers in the small group market are largely independent of state rate regulations. No matter what type of rate regulations used by the states, between 1997 and 2001, the number of insurers offering health insurance in the small group market nationally, declined by 12 percent.
  
• Rate regulations are used to change the risk distribution of the uninsured population. Adjusted community rating tends to increase the likelihood that higher risk groups can get coverage while slightly increasing the likelihood that lower-risk groups will drop coverage.
  
• Because they spread risk over a larger number of people, adjusted community rate regulations help protect small businesses and their employees from large premium increases when workers or their families experience largely random health events such as contracting cancer or getting hurt in an automobile accident.
  

Introduction

Since the 1990s, states have attempted to reform their small-group health insurance markets in an effort to make insurance more accessible and affordable to small employers and their workers.

Reforms have included requiring carriers to sell coverage to all applicants regardless of age or health, creating high-risk pools for those with pre-existing conditions, and placing limits on how much health insurance premiums can vary according to the insured person’s age, place of residence or health status.

Regardless of a state’s rate regulations, no state has yet stopped the ongoing tide of premium rate increases or the decline of small employer-sponsored insurance.

This policy brief attempts to put small-group insurance rate regulation in perspective. The reader needs to be aware that identifying direct relationships between small-group regulations and outcomes is impossible. There are too many factors, too much variation and insufficient data to make airtight conclusions. What can be done, however, is to look at general patterns and trends in the small-group market across states. By comparing certain indicators, structural market forces that may be impacting insurers and costs can be better identified.

Section 1 presents a brief overview of the rationale for health insurance and insurance regulation in the small-group market. It also summarizes Colorado’s small-group market reform efforts.

Section 2 briefly discusses the controversy surrounding small-group market rate regulations, looks at research findings and describes the public policy concerns of achieving affordable health insurance through the small-group market.

Section 3 takes a closer look at changes in the small-group insurance market, growth in average total premium costs, changes in the structure of the market and trends in health care expenditures.

To assess whether or not Colorado’s rate regulations have had a unique impact on premium costs and on the small-group market, we compare Colorado and seven other states on three factors:

• Average total premium cost.
• Percent change in the number of small-group insurers leaving the market between 1997 and 2001.
• Percentage of small firms offering health insurance.

While each state’s small-group market rate regulations vary, all states in the sample offered small-group coverage to individuals and/or the self-employed in some form. Sample selection methods are discussed in greater detail in Appendix A.

Section 3 also examines changes in market structure by reviewing health care expenditures and the market share of insurers in the small-group market.

In this brief, health expenditure data are used to show changes in overall health care costs over time. It is assumed that these data reasonably represent the aggregate impact of factors, such as an aging population, increasing use of more advanced and expensive technologies and prescription drugs, and changes in benefit packages.

The Bell Policy Center endorses reforms that improve availability and affordability, including requiring insurers to offer coverage to all, with reasonable waiting periods for pre-existing conditions, requiring evidence-based standardized benefits, limiting rating factors and rate variation, finding ways to insure individuals through the small-group market, and most importantly, supporting the SB 06-208 Health Care Commission Task Force in its effort to move Colorado toward comprehensive health care reform.

Section 1. States, small employer insurance and rate regulation

Since World War II, employer-sponsored health plans have provided the primary source of health coverage for the majority of workers and their families. Indeed, most of the financing for private health insurance comes from employers’ contributions to worker health insurance premiums. Until Colorado is able to identify other means for financing private health insurance, the state must do whatever it can to make sure that the existing employer-based system of providing health insurance continues to serve as many Colorado families as possible.

More than half of the nation’s private sector workers are employed by a small business. In today’s economy, small businesses create new jobs at a faster rate than larger employers.1 While small business dominates the working landscape, increasing numbers of small businesses cannot afford to provide health care for workers. As health insurance costs go up, many small employers drop coverage and others decide not to offer health plans at all.

In a 2006 nationwide survey, the Kaiser Health Research and Educational Trust found 74 percent of small businesses (employing three to 50 workers) cited high premiums as a major reason why they did not offer health coverage.2 Nationally, the cost of employer-based coverage increased 68 percent since 2001.3 

Small-group premiums are higher, in part, because health care costs for small firms are less stable and harder to predict.4 One employee or dependent in poor health can dramatically increase health care costs for a small firm. In contrast, large insurance risk pools have the advantage of spreading catastrophic health care costs over a wider range of low-risk and high-risk workers and their families. This economy of scale helps to stabilize premium variations and lower the overall cost of premiums.5

Increasingly, high premium costs have led more small firms to offer plans with fewer benefits and higher deductibles compared to health plans offered by larger companies.6 But health insurance policies with high deductibles, co-pays, and many exclusions offer little protection during a serious illness.

The Kaiser study found that uncovered medical bills averaged $13,460 for people with private insurance at the start of their illness. People with cancer had average medical debts of $35,878. The study found that illness and medical bills caused half of the 1.5 million personal bankruptcies in 2001 — and most of those bankrupted by illness were middle class, owned a home and had health insurance.7 

Why have health insurance?

Insurance is a method for spreading risk among many people so that when financial loss occurs, it is manageable. In principle, insurance is based on “risk pooling” and the “law of numbers.” With risk pooling, money from many people is pooled to pay for the losses incurred by a few. About 10 percent of individuals account for about 70 percent of all health care spending.8 The law of numbers is a statistical principle whereby the larger the group, the better insurers can accurately predict future losses, that is, paying for medical claims, that may occur within a group for a given period of time.

Why small-group rate regulations?

Without health insurance, it’s hard to pay for health care.9 But making certain that as many people as possible have health insurance serves important public policy goals, such as stopping the spread of disease, promoting healthy lifestyles, protecting consumers from discriminatory and inequitable standards, and assuring financial solvency of insurance companies.10 

Because small-group insurance is largely regulated by states,11 states can create their own economy of scale by allowing all policy holders with the same benefit plan within a particular small-group to be charged the same premium regardless of claims experience, health status, gender or other factors. Without legislative interventions, insurers tend to adopt practices that minimize risk or losses, such as denying coverage or charging excessive premiums to people with a history of health problems.

Since the mid-1990s, most states, including Colorado, have attempted various small-group market reforms to address problems of affordability and coverage. In addition to requiring insurers to offer guaranteed issue and renewal policies for small groups, many states limit rate variation, especially with respect to health status and claims experience, which are known to contribute to the volatility of premiums for small-groups.12 The two basic types of insurer restrictions are rate bands and community or adjusted community ratings.

Rate bands limit how much an insurer can vary premiums based on specific case characteristics such as health status, claims experience or age. For example, an insurer can vary a particular firm’s premium rates year to year based on specific case characteristics, such as the combined health status of the firm’s workers. The amount premiums can vary depends on state regulation. Usually premiums cannot increase or decrease by more than 15 percent. Insurers can also add a renewal surcharge in addition to any increase that would otherwise apply to all policyholders due to the cost of medical care.13

Setting initial premium rates based on case characteristics like health status and claims experience is also known as medical underwriting. When small-group plans are medically underwritten, workers are asked to provide health information about themselves and covered family members when they apply for coverage. Insurers use this information to set initial rates. In addition, insurers often charge higher premiums to individuals or small-groups that they expect will have higher costs, such as people with chronic conditions like diabetes.

Community or adjusted community rating is an alternative to medical underwriting. Under community rating, premiums reflect the average claims experience of all small-groups in an insurer’s portfolio. At renewal, premium increases are based on the claims experience of all people with the same policy, so businesses or individuals who had claims are not charged more than the others in the group.

Adjusted community rating is similar to community rating, except that rates may vary by other factors as well. For example, an adjusted community rate provision could allow insurers to increase or decrease premiums based on tobacco use among workers in a small firm. The insurer could not, however, vary premiums based on health status. At renewal, base premium increases are determined by the claims experience of all people with the same policy, while the index rate for smokers is allowed to vary.

Colorado’s small-group rating regulations

Under HB 94-1210, Colorado adopted premium rating rules suggested by the National Association of Insurance Commissioners (NAIC). The NAIC develops coordinated and uniform regulations of multi-state insurers. Colorado’s 1994 provision allowed premiums to vary from a chosen health benefit plan’s index rate based on the factors of age, family composition or geographic location. The 1994 law also added a “business group of one,” called “BG1,” to the definition of a small-group. Under this definition, sole proprietors and firms with less than 50 employees had guaranteed access to basic benefit packages offered by small-group insurers.14

In 2003, the Colorado legislature passed HB 1164, which allows small-group insurers to vary the index rate of premiums based on health status, claims experience, type of industry and tobacco use of the employer’s group of workers.

In Colorado, small-group insurance premiums must begin with an insurance carrier’s base premium rate (CRS 10-16-102(3)), which is the lowest premium charged to small employers with similar case characteristics for particular health benefit plans.

From the base rate, premiums are indexed according to age, geographic area, family composition, type of industry, tobacco use, claims experience and the health status of the employer’s group of workers (CRS 10-16-105(3)(e) and CRS 10-16-105(8)(f)(I)). The index rate is the rate all small-group carriers are to charge. It is the arithmatic average of the applicable base premium rate and the corresponding highest premium rate for small employers with similar case characteristics.

After Sept. 30, 2004, small-group insurers were permitted to vary group premium rates by 10 percent above and 25 percent below the base rate, but could not increase the rates from year to year based on claims experience, health status, standard industrial classification or tobacco use for the group by more than 15 percent (CRS 10-16-105(8.5)).

In 2007, HB 1355 was passed by the legislature and signed by the governor. This bill modifies HB 03-1164 by disallowing small-group insurers to use health status and claims experience to rate premiums up or down. All other band rates — age, geography, industry, tobacco use and family composition — remain in statute.

Section 2. Do community or adjusted community rates increase premium cost more than band rates?

There is a great deal of controversy and confusion about whether or not requiring community or adjusted community ratings in the small-group market substantially increases premium costs for small employers. Advocates of community or adjusted community rating argue that consumers are better protected from substantial premium cost increases when they become sick or insured. They also argue that because this type of insurance rating structure is simplified, premiums vary less and the reasons behind rate increases or decreases are more evident.

Critics of community or adjusted community rating, on the other hand, argue that such regulations increase adverse selection, which is disproportionate enrollment of people with more health problems. Over time, this imbalance pushes healthier people out of the market, forcing costs up. Insurers also cite market competition theory, which holds that when insurers are forced to pool risks that would otherwise be denied or segmented, costs go up. Once costs go up, premiums increase, coverage rates decline and some insurers will leave the small-group market.

Evidence can be found to support each side. For example, some research indicates that because pooling risk is less data intensive, it can substantially cut administrative costs and limit total spending. Studies suggest that as much as 20 to 25 percent of premiums paid by small firms go to covering administrative expenses, such as marketing and billing, compared to 10 percent for larger firms.15 Other research suggests that pooling better moderates risks, stabilizes premium costs and can help make insurance more available and affordable.16 

Research also suggests that premiums may be slightly higher in community rated markets and that some lower-risk people may opt out of employer-sponsored insurance. For example, the Robert Wood Johnson Foundation found that average health insurance premiums are slightly higher in community rated markets, but the increase reflected the greater ability of older and sicker people to afford coverage.17  Another study found that low-risk workers, such as single men under 36, were slightly more likely to be uninsured in states with community or adjusted community regulations.18

Researchers stress, however, that identifying direct correlations between rate regulations and premium costs is nearly impossible because so many factors exert influence on the small-group market — from the health of the general population to insurance underwriting cycles.19 

Research also identifies a few common tendencies in small-group markets with community/adjusted community rate regulations:

• Small and mid-sized firms generally have lower per-person health care costs.20  
• The difference between the highest premium rate and the lowest premium rate for the same health insurance plan is larger when health status and claims experience are included in setting premiums.21 
• Since participation in health insurance plans is voluntary, healthier people are more likely to opt out, regardless of premium costs.22 
• Rate regulations can change the risk distribution of the insured population, so higher-risk people are more likely to take up coverage and lower-risk people are slightly more likely to drop coverage.23, 24  
• When health insurance carriers are allowed to set premiums based on many case characteristics, such as health status and claims experience, they tend to reduce their risk liability by pricing or tailoring benefits to avoid certain medical costs. This boosts the number of small employers that change or drop carriers and coverage, which contributes to greater premium volatility and more underinsured and uninsured workers.25

Rate regulations are intended to prohibit unfair practices, but it is not entirely clear what role they play in relation to premium price fluctuations. In general, national studies suggest that premium costs are largely independent of state rate regulations.26 Conversely, a growing number of studies indicate that fluctuations in premium costs reflect changes in the health care marketplace,27 a topic that is discussed in greater detail in the following section.

Section 3. The health care marketplace and health care premiums

In many ways, health insurance premiums have become the focal point of a larger philosophical concern: What is the role of competition in health care markets? Some argue that health care is a public good, and competitive economic forces should not apply. Others view health care as a service best handled in the marketplace.

Regardless of philosophy, public insurance programs and private insurance companies do respond to competitive pressures to contain health care costs. For example, Medicaid has adopted new forms of payments to health care providers in an effort to cut costs. Providers responded by entering into new types of joint ventures, and some hospitals are consolidating through mergers or by forming multi-hospital networks.28 Private companies have changed the structure of insurance plans and consolidated through mergers or acquisitions.

Changes in small-group insurance plans

Nationally in the 1980s, the small-group market sold mostly traditional indemnity health plans, also called “fee-for-service.” With indemnity plans, once the deductible is met, the insurer generally pays 80 percent of the “usual and customary charge” and the customer pays the other 20 percent. Indemnity health plans offer people the freedom to choose their health care professionals, but premiums and out-of-pocket expenses can be substantial.

Toward the end of the 1980s and early 1990s, the small-group market began to offer health maintenance organization (HMO) plans as an alternative to traditional indemnity plans. HMOs are essentially pre-paid health plans. Customers pay a flat monthly rate, and coverage is provided for visits to providers within the HMO network only, with no deductibles. The HMO must first clear any non-network visits, prescriptions or other care for it to be covered. By the early 1990s, HMOs fell out of favor with providers and consumers for being overly restrictive and preventing necessary care.

In response to this backlash against HMOs, the small-group market began to offer preferred provider organization (PPO) plans. PPO plans are a type of managed care, in which a network of physicians, hospitals and other providers are paid a reduced fee. In PPOs, health care is paid for as it is received, instead of in advance as with HMOs.

PPOs offer more flexibility for out-of-network visits, but they have higher deductibles or co-payments. While PPO premiums can be comparable to HMO premiums, additional fees associated with PPO plans substantially increase the cost of health care for policy holders.

While the small-group market continues to offer indemnity, HMO and PPO plans, indemnity plan enrollment has dropped off substantially nationwide. In Colorado, indemnity plans in the small-group market fell from 4 percent in 2000 to 1 percent in 2006. In 2000, 59 percent of plans were HMOs and 37 percent PPOs. By 2006, only 36 percent of plans were HMOs and 63 percent were PPOs.29

Some insurance companies argue that higher premiums and the growing popularity of HMO and PPO plans compared to indemnity plans is the result of federal and state “guarantee issue” policies. Guarantee issue requires insurers to offer guaranteed coverage, regardless of individual health status. Research shows, however, that the movement away from indemnity plans toward managed care plans is actually part of a larger, ongoing movement to control health care costs.30 

Changes in state rate regulations

At the same time small-group insurers have been adjusting the payment structure of insurance plans, states have implemented rate regulations to make health care affordable for more people while helping to contain costs.

As mentioned in Section I, without health insurance it is difficult to access health care services. Thus, public health policies have a responsibility to promote healthy lifestyles and protect consumers from unfair practices. Because small firms are at a disadvantage when it comes to purchasing health insurance — smaller groups to spread risk and less bargaining power for the best insurance products and prices — states set small-group rate regulations to encourage greater risk pooling, cut the chances of being denied coverage or paying excessive premiums, and limit the volatility of changing premiums costs.

Insurers argue that rate regulations translate into dramatic premium rate hikes. Yet there is little empirical evidence to support this argument. The following figures show that in each state we studied, the average total cost of premiums increased between 2000 and 2004, regardless of rating regulations. The figures also show that in 2002 or 2003, the average cost of premiums did not increase as much as it had in previous years.

Figure 1. Average total premium cost per employee for single coverage for firms with fewer than 50 employees, by selected states, 2001-2004 (not adjusted for inflation)

Figure 2. Average total premium cost per employee for family coverage for firms with fewer than 50 employees, by selected states, 2001-2004 (not adjusted for inflation)

Source for Figs. 1 and 2: Medical Expenditures Panel Survey (MEPS). MEPS-IC state tables, downloaded April 19, 2007. Colorado is labeled a rate band state. This was true in September 2004. However, premium costs shown here occurred when Colorado used an adjusted community rate.

While the impact of rate regulations is difficult to assess, research suggests that, in general, states with band rate variations tend to have slightly more insurers participating in the small-group market.31 

Insurers argue that fewer rate restrictions allow them to better estimate health risks and medical claim costs. The ability to more accurately determine medical costs allows small-group insurers to maintain a reasonable medical loss ratio, which is the portion of total premium costs going directly for clinical services compared to the portion of total premium costs going for administrative costs and profits. A reasonable medical loss ratio allows more companies to sell insurance policies, which increases market competition and drives down premium costs.

Generally, higher profits attract new companies to the market and drive more intense price competition. After a time, increased price competition leads to underwriting losses, as premiums trends fall behind health cost trends. As insurers exit unprofitable markets or lines of business, the remaining insurers raise premiums above costs, driving a return to profitability and a repeat of the “underwriting cycle.”32 Historically, the health insurance underwriting cycle follows a regular pattern of three years of profitability followed by three years of losses. Since 1965, there have been 11 such “tops and bottoms.”33

But in practice, rating on case characteristics creates a much different form of small-group market competition. Instead of competing to keep costs down for all policyholders, rating premiums up or down based on specific case characteristics segregates people with more health risks from those with fewer health risks. The end result is that small market insurers compete for younger, healthier customers over those who are older or less healthy.

Regardless of state rate regulations, between 1997 and 2001, many small-group insurers either left the market or were acquired by or merged with larger carriers, such as Anthem Blue Cross Blue Shield, United Healthcare or Kaiser. Nationally, the number of insurers in the group market fell by 12 percent during this time.34 This shift created a concentrated small-group market in which a few large insurers have a degree of monopoly power and some discretion about premium pricing.

Figure 3 shows the percentage change in the number of small-group insurers by selected states, state. A complete list of the percent change in insurers by state can be found in Appendix B.

Figure 3. Change in number of insurers by selected state in the small-goup market, 1997-2001

Source: Adapted from Mathematica Policy and Research and AcademyHealth, Washington, D.C. (Table 4, p. 12)

Regardless of the number of small-group insurers in the market, premium costs continue to increase and fewer small firm employers are offering health insurance to their workers. In every state, small firms are much less likely to offer health insurance to workers than are large firms.

As Figure 4 shows, among the comparison sample of eight states, 93 to 100 percent of large employers offered health insurance plans in 2004. In contrast, between 39 and 54 percent of small firms offered health insurance to their workers. Interestingly, small firms in states with community or adjusted community ratings — Massachusetts, Maryland, New Jersey, New York — were somewhat more likely to offer health insurance compared to small firms in states using rate bands.

Figure 4. Percent of large and small firms offering health insurance to workers, 2004

Source: Medical Expenditure Panel Survey Data, IC Table for 2004 (IIA2). Downloaded April 19, 2007.

Health care cost drivers

So far, this brief has shown that average total premium costs are not directly related to small-group rate regulations, benefit plan type, the number of insurers in the small-group market or the level of small-group market concentration. While each may influence costs, none directly address the growth of health care costs in the broader health care system, such as an aging population or increased use of more advanced technologies, procedures and prescription drugs.

Health spending data highlights trends in the marketplace. National and state health spending data show that since 2003, spending has increased, but more slowly than in the early years of the decade.

For example, national health care spending as a share of gross domestic product (GDP), remained relatively constant during the 1990s, began to rise fairly rapidly after 2000 and then leveled off in 2004. In 2004, health care expenditures were $1.9 trillion, or 16 percent of the GDP, compared to $717 billion in 1990, when it was 12.4 percent of GDP or $255 billion spent in 1980, 9.1 percent of GDP.35

Colorado shows a similar pattern. As Figure 5 shows, Colorado’s health care expenditures grew from $7.7 billion in 1990 to $22.3 billion in 2004.

As a share of state gross product, Figure 6 shows that Colorado’s health care spending declined slightly, from 10.3 percent of SGP in 1994 to a low of 9.4 percent in 2000, before rising to a high of 11.1 percent in 2003.

Even though growth in health care spending and insurance premiums has slowed, health care inflation continues to grow faster than consumer-price inflation and growth in workers wages.36 Experts are uncertain how long the slowdown in premium increases will last, noting that in the past, periods of “moderating premium trends are soon followed by periods of escalating rates of increase.”37

Figure 5. Colorado health spending in millions of dollars, 1980-2004, not adjusted for inflation

Source: Centers for Medicare and Medicaid Services, Health Expenditures by State. State estimates for public and private payers.

Figure 6. Colorado health spending as a share of state gross product (SGP), in millions of dollars, 1980-2004, not adjusted for inflation

Source: Centers for Medicare and Medicaid Services, Health Expenditures by State. State estimates for public and private payers.

Conclusion

Rapidly increasing premiums, declines in employer-sponsored insurance and growing numbers of uninsured working adults remain a major concern for Colorado. Attempts to control costs and increase access through rate regulations have, as research shows, only a minimal impact. In fact, identifying direct cause-and-effect relationships between rate regulations and premium costs is impossible because there are too many factors at play.

Research does show that regardless of what rating structure a state uses, premium costs tend to follow a similar pattern over time. Between 2001 and 2004, the states selected for comparison in this brief followed the same growth pattern regardless of state regulations.

Though rate regulations alone will not fix the problem, research shows that community or adjusted community ratings help prevent the small-group market from tailoring benefits to attract healthy workers, who usually have fewer claims. Community or adjusted community ratings also limit the market’s ability to set excessive premiums for less healthy workers.

Finally, community or adjusted community ratings are being used by every state initiating comprehensive health care reform, and are being considered as part of a national health reform strategy.38

Appendix A: Methodology

States have enacted a variety of programs and regulations to reduce the cost of small-group coverage and to encourage employers to offer plans to workers. Some states, like Colorado, provide coverage in the small-group market for individuals or the self-employed.

Ongoing reforms to the small group market and significant variations in state rate regulations make it impossible to find exact state comparisons. According to the National Association of Health Underwriters (NAHU), in 2006, 40 states allowed for medical underwriting in the small-group market. 

Eleven states — Colorado, Connecticut, Delaware, Florida, Maine, Maryland, Massachusetts, Mississippi, North Carolina, Rhode Island and Vermont — define small employer groups in statute as 1 to 50 employees. Other states have a separate class for sole proprietors.  Regardless of state regulatory differences, individuals wanting to obtain coverage as a business group of one must satisfy criteria set by the carrier. 

For this report, we evaluated the impact of Colorado’s rating regulation against seven states that provide some type of coverage for the self-employed in the small-group market: Arizona, Maine, Maryland, Massachusetts, Minnesota, New Jersey and New York. Each of these states were highlighted in a 2005 testimony to The Alliance for Health Reform in Washington, D.C., by Deborah Chollet of Mathematica Policy Research as states that recently enacted programs to reduce the cost of small-group coverage and encourage employers to offer it.  

It is important to note that states use a variety of mechanisms, such as state subsidies, to make insurance more affordable in the private small-group insurance market. Subsidy programs help stabilize premium variations and increase employer offerings. Programs most often include tax credits and premium assistance, purchasing alliances or reinsurance mechanisms.39 The influence of state subsidies on premium costs was not considered in this brief.

Each state was categorized as a band rate, adjusted community or pure community regulated state, according to the Kaiser Family Foundation’s 2006 data on U.S. small-group Health Insurance Market Rate Restrictions.40 No adjustments to rate regulation categories were made if a state changed regulations prior to 2006.

For example, Colorado was an adjusted community rate state until 2003, when it became a band rate state. The time period of the data used to determine premium costs variations is between 2001 and 2004.

Premium cost variations for each state were determined using 2001 – 2004 Medical Expenditures Panel Survey (MEPS) data, the latest data available for state comparisons. Only the average total premium costs for single coverage and for family coverage for businesses with fewer than 50 employees were used for this analysis.

Appendix B: Number of insurers by state and percent change, 1997-2001, for the small-group market

Source: Mathematica Policy and Research and AcademyHealth, Washington, D.C. (Table 4, p. 12)

End notes

1. U.S. Small Business Administration (2006). Small Business Drives the U.S. Economy, Press Release No. 06-17 ADVO. Office of Advocacy, U.S. Small Business Administration. In 2005, according to the U.S. Small Business Administration, small businesses — defined as 500 employees or less — represented 99.7 percent of the nation’s employer businesses. More than half, 50.6 percent, of the nation’s private sector workforce were employed by a small business.

2. Kaiser Family Foundation (2006). Kaiser Public Opinion Spotlight, Public Opinion on the Uninsured, updated January 2006.

3. Kaiser Family Foundation and Health Research and Educational Trust (2006). Employer Health Benefits 2006 Annual Survey. Kaiser-HRET, Employer Health Benefits.

4. Gabel, J.R. & Pickreign, J.D. (2004). Risky Business: When Mom and Pop Buy Health Insurance for Their Employees, Task Force on the Future of Health Insurance, Issue Brief, Health Research and Educational Trust, Commonwealth Fund.

5. Williams, C. and Lee, J. (2002). “Are health insurance premiums higher for small firms?” Policy Brief No. 2. Robert Wood Johnson Foundation.

6. Chollet, D. and Achman, L. (2003). Approaching Universal Coverage: Minnesota’s Health Insurance Program. The Commonwealth Fund.

7. Himmelstein, D.U., Warren, E., Thorne, D. and Woolhandler, S. (February 2, 2005). MarketWatch: Illness And Injury As Contributors To Bankruptcy. Health Affairs Health Tracking.

8. Berk, Marc, and Alan Monheit, (March/April 2001) “The Concentration of Health Care Expenditures, Revisited,” Health Affairs: 145-149.

9. Kaiser Family Foundation (2006). The uninsured and their access to health care. Kaiser Commission on Medicaid and the uninsured key facts. Washington, D.C.

10. Kofman, M. and Pollitz, K. (2006). Health Insurance Regulation by States and the Federal Government: A Review of Current Approaches and Proposals for Change, Health Policy Institute, Georgetown University, Washington, D.C.

11. The Health Insurance Portability and Accountability Act of 1996 (HIPPAA) requires guaranteed issue of individual coverage for people with prior continuous coverage in the group market. In addition, under federal law, small group health insurance must be offered to small business on a guaranteed issue basis. That is, small business cannot be denied health insurance coverage on the basis of the health status or illness of its employees or their dependents. However, businesses regardless of size are not required by law to offer insurance to employees.

12. Chollet, D., Smieliauskas, F. and Konig, M. (2003). Mapping State Health Insurance Markets, 2001: Structure and Change. AcademyHealth, The Robert Wood Johnson Foundation.

13. Ibid. Kofman, M. and Pollitz, K. (2006), end note No. 10.

14. Small Employer Health Insurance Availability Model Act” NAIC (2001). Model #118, Model Laws, Regulations, and Guidelines, 118-13.

15. General Accounting Office (2001). Private Health Insurance: Small Employers Continue to Face Challenges in Providing Coverage, GAO-02-8. There are no reliable data comparing insurance costs for the same benefit packages between large and small firms. While insurance companies would have the best information, their data are proprietary.

16. See, for example:
“Did Community Rating Induce an Adverse Selection Death Spiral? Evidence from New York, Pennsylvania and Connecticut,” American Economic Review, Vol 92(1):280-294;
America’s Health Insurance Plans (AHIP) Center for Policy and Research (2006). Small group health insurance in 2006: A Comprehensive Survey of Premiums, Consumer Choices, and Benefits;
Robert Wood Johnson Foundation (2005) Making Health Insurance More Affordable for Small Businesses;
Gencarelli, D.M. (2005). Health Insurance Coverage for Small Employers, National Health Policy Forum, George Washington University.

17. Buchmueller, T. C. and DiNardo, J. (1999). “Did Community Rating Induce an Adverse Selection Death Spiral? Evidence from New York, Pennsylvania, and Connecticut.” National Bureau of Economic Research Working Paper No. 6872, 5-6;
see also, Fuchs, B. (2004). Expanding the Individual Health Insurance Market: Lessons from the State Reforms of the 1990s, The Robert Wood Johnson Foundation, Research Synthesis Report No. 4.

18. Chollet, D., Smieliauskas, F. and Konig, M. (2003), end note No. 12.

19. Williams, C.H. and Fuchs, B.C. (2004). Expanding the individual health insurance market: Lessons from the state reforms of the 1990s. The Synthesis Project, Policy Brief No. 4, Robert Wood Johnson Foundation; Kipp, R., Cookson, J.P. and Mattie, L.L. (2003).
Health Insurance Underwriting Cycle Effect on Health Plan Premiums and Profitability, Milliman USA, Consultants and Actuaries. Brief No. 41FAH 6558.

20. Robert Wood Foundation (2005). “Making Health Insurance More Affordable for Small Business”;
Gencarelli, D.M. (2005), end note No. 16.

21. Senkewicz, M. (2006). Senate health bill would preempt states’ small group rating rules, Center on Budget and Policy Priorities.

22. Robert Wood Johnson Foundation, end note No. 20.

23. Kofman, M. and Pollitz, K. (2006), end note No. 13.

24. Buchmueller, T. C. and DiNardo, J. (1999), end note No. 17;
see also, Fuchs, B. (2004). end note No. 17.

25. Chollet, D., Smieliauskas, F. and Konig, M. (2003), end note No. 12.

26. Chollet, D. J., Kirk, A. M and Simon, K.I. (2000). The Impact of Access Regulation on Health Insurance Market Structure. Submitted to the Office of the Assistant Secretary for Planning and Evaluation. U.S. Department of Health and Human Services in partial fulfillment of Contract HHS-10098-0014.

27. Ibid;
see also Chollet, D., Smieliauskas, F. and Konig, M. (2003), end note No. 12;
Grossman, J.M. and Ginsburg, P.B. (2004), end note No. 32;
and the Kaiser Family Foundation (2006), end note No. 35.

28. Federal Trade Commission and U.S. Department of Justice, Antitrust Division (2004). Improving health care: A dose of competition.

29. Colorado Division of Insurance, Small Activity Reports 2000 and 2006. Colorado Department of Regulatory Agencies.

30. Fuchs, B. (2004), end note 24;
see also Gabel, J.R., Ginsburg, P.B., Whitmore, H.H. and Pickreign, J.D. (2000). Withering On The Vine: The Decline Of Indemnity Health Insurance. Health Affairs, Vol. 19, No. 5.

31. Chollet, D. J., Kirk, A. M and Simon, K.I. (2000), end note No. 27.

32. Grossman, J. M. and Ginsburg, P. B. (2004). As the Health Insurance Underwriting Cycle Turns: What Next? Health Affairs, Vol. 23, No. 6. Center for Studying Health System Change.

33. St. Luke’s Health Initatives (2003). Health Insurance Rate Regulation in Arizona.

34. Chollet, D., Smieliauskas, F. and Konig, M. (2003), end note No. 12.

35. Kaiser Family Foundation (2006). Trends and Indicators in the Changing Health Care Marketplace. Information from the Health Care Marketplace Project, Publication No. 703;
and the Centers for Medicare and Medicaid Services, Office of the Actuary, National Health Statistics Group. U.S. Department of Health and Human Services.

36. Kaiser Family Foundation and Health Research and Educational Trust (2006). 2006 Annual Survey: Employer Health Benefits. Report prepared by The Kaiser Family Foundation, the Health Research and Educational Trust, and the Center for Studying Health System Change, Washington, D.C.

37. Claxton, G., Gabel, J. Gil, I., Pickreign, J., Whitmore, H., Finder, B., DiJulio, B. and Hawkins, S. (2006, p. 484). Health Benefits In 2006: Premium Increases Moderate, Enrollment In Consumer-Directed Health Plans Remains Modest. Health Affairs Health Trends WebExclusive: 476-485. Abstract available online.

38. Commonwealth Fund (2007). Congressional Health Care Bills, 2005-2007: Part I Insurance Coverage;
and New Proposals Would Share Responsibility for Insurance Coverage

39. Kofman, M. and Pollitz, K. (2006), end note No. 10.

40. Kaiser Family Foundation (2006). State health facts: Small Group Health Insurance Market Rate Restrictions, 2006.