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FRBSF Economic Letter
98-12; April 17, 1998
Health Insurance and the U.S. Labor Market
Health insurance in the United States largely is employment-based: nearly
90% of Americans with private insurance are covered through employer-provided
plans. Furthermore, health insurance is the largest nonwage component
of total compensation, accounting for 34% of expenditures on voluntary
employee benefits and 7% of total compensation (U.S. BLS 1994). Combined,
these facts suggest that employer provision of health insurance is an
important feature of the U.S. labor market. In this Economic Letter,
we describe some unique aspects of the market for employer-provided health
insurance, and we discuss their implications for several key employee
decisions: job mobility, retirement, and hours worked. We conclude by
discussing the policy implications of recent research findings.
The economic rationale for employer-provided
health insurance
Although the earliest employer-sponsored health plans date to the 1920s,
two public policies from the 1940s and 1950s firmly established the link
between health insurance and the workplace. First, during World War II
Congress responded to excess demand for labor by enacting limits on the
extent to which employers could increase wages. Since these limits did
not apply to fringe benefits, many employers began offering health insurance
to attract and retain workers. Second, in 1954 the IRS created a permanent
incentive for employers to substitute in-kind benefits for cash wages
by declaring that fringe benefits are not taxable. Although workers ultimately
pay for health insurance, either through direct premium contributions
or reduced wages, this tax treatment provides a powerful incentive for
workplace provision of health insurance.
Another incentive is the cost savings associated with risk pooling and
minimizing "adverse selection." In risk pooling, insurers diversify
their risk by spreading it across a large number of individuals; "adverse
selection" refers to the tendency for individuals with the highest
expected health care costs to be the most likely to buy insurance. Given
these factors, insurers can reduce costs by selling insurance to groups
of people that are formed for reasons other than purchasing insurance,
such as all the workers at a single large firm.
Despite these incentives for tying health insurance to employment, doing
so can affect other job-related decisions by workers. In the rest of this
Economic Letter we discuss the influence of employer-provided
health insurance on several key labor market decisions, and recent policy
initiatives aimed at reducing these behavioral side effects..
Job mobility
"Job lock" is one effect of employer-provided health insurance
that has received a great deal of attention from the media, policymakers,
and academic economists. Job lock is defined as a reduction in workers'
willingness to quit jobs (reduced voluntary job mobility) arising from
the risk of losing health coverage. This effect refers not to reduced
mobility arising from the monetary value of health insurance, but rather
to any additional reductions in mobility arising from risk and information
problems associated specifically with insurance markets. For example,
an important source of job lock is "pre-existing condition"
clauses, which insurers often invoke to deny full employment-based medical
coverage to a new employee who has a medical condition at the time of
job change.
Workers without pre-existing medical conditions also may experience
job lock. The risk of being uninsured between jobs raises expected search
costs, thereby reducing workers' willingness to endure the unemployment
that may be required for optimal job search. Moreover, employer-sponsored
health insurance plans often impose probationary periods of up to several
months, during which new employees are denied full health coverage, and
job changers may lose credit toward deductibles and out-of-pocket expenditure
limits from their previous plans. Each of these factors increases the
expected cost of job change and perhaps reduces voluntary mobility.
Measuring the extent of job lock is complicated by the tendency for
insurance-providing jobs to be "good jobs"--i.e., to be highly
desirable for a number of reasons besides the provision of health insurance.
To overcome this problem, several studies (including Buchmueller and Valletta
1996) have used a quasi-experimental design to investigate the extent
of job lock. These studies compared the job change behavior of individuals
who are covered only under their own plan (and therefore are subject to
job lock) with that of individuals who also are covered through a spouse's
plan (and therefore are not subject to job lock). Our results suggested
that job lock induced by employer-provided health insurance substantially
reduces voluntary job mobility for married women; the results for married
men were not statistically significant. Although a similar test can not
be applied to unmarried workers, we applied an alternative test to this
group and once again found more evidence of job lock for women than for
men. The estimated reductions in female job mobility were large, on the
order of 30--50%.
Additional evidence is provided by examining the impact of state "continuation
of coverage laws," which specify that separated employees be allowed
to purchase group coverage from their former employers at a comparable
rate for up to 18 months after separation. Gruber and Madrian (1997) report
that such laws raise voluntary turnover rates for men with health insurance
by 14%, which suggests the presence of substantial job lock in the absence
of such laws. They also found that, although unemployment spells are longer
in continuation of coverage states, wage gains after unemployment are
larger. This suggests that the relaxation of job lock constraints enhances
the quality of the job search and matching process, which is a key rationale
for continuation of coverage laws.
Retirement
Retirement is another type of job change decision that is affected by
health insurance availability. The availability and cost of health insurance
is a critical issue for retired and older workers, because both the magnitude
and variability of medical expenses increase substantially with age (Gruber
and Madrian 1995). As a result, the cost gap between employer-provided
group insurance and equivalent individually purchased private insurance
also increases with age.
Gruber and Madrian investigated the relationship between health insurance
and retirement by estimating the effects of state continuation of coverage
laws on the timing of retirement. The ability to purchase post-retirement
health insurance at a rate comparable to that under a former employer's
plan may lead to earlier retirement. This effect is limited, however,
by the duration of continuation coverage (18 months) and availability
of alternatives (primarily employers' post-retirement health plans, and
Medicare at age 65).
Using data from the 1980s, Gruber and Madrian found that by acting as
a "bridge to Medicare" the availability of continuation coverage
substantially increases retirement probabilities for men aged 55--64;
in particular, each additional year of coverage raises the probability
of retirement in a given year by 30%. Their results also suggest that
each year of post-retirement insurance coverage is valued at $13,600,
a figure that is 3--4 times greater than the implied cost differential
between employer-provided and individual private insurance. Although this
figure is large, it may be explained by an inability of many retirees
(particularly those with pre-existing conditions) to obtain individual
insurance at all.
Labor supply
The retirement decision also can be viewed as a labor supply decision;
it represents older workers' decision to supply zero hours of labor. However,
employer-provided health insurance is likely to have more general effects
on the hours worked decision. Because employers seldom offer health insurance
to part-time workers, employees in general must work full-time in order
to acquire health insurance.
There are two key reasons why employers often limit health insurance
to full-time workers. First, health insurance benefits represent a "quasi-fixed"
cost that varies with the number of workers rather than the number of
hours; on an hourly basis, this makes health insurance more expensive
to provide to part-time workers. Second, IRS non-discrimination rules
limit the ability of firms to offer different benefit packages to different
groups of full-time employees but allow the differential treatment of
full-time and part-time employees. Part-time employees are more likely
to be low-wage workers, and for some low-wage workers health benefits
are likely to be a larger fraction of total benefits than they prefer.
Thus, excluding part-time workers from fringe benefit plans is one way
that employers can exclude low-wage employees from their health plans
without violating IRS non-discrimination rules.
The restriction of health benefits to full-time workers, combined with
the high value of such benefits, suggests that some workers who prefer
to work part-time may instead work full-time in order to acquire health
insurance for themselves and their families. Such behavior is rare among
male household heads, since the overwhelming majority of them work full-time
for reasons unrelated to insurance provision. However, married women whose
husbands do not have insurance may engage in such behavior on a widespread
basis.
In a recent paper (Buchmueller and Valletta 1999) we tested this proposition
empirically, using 1993 household survey data and a technique that accounts
for both observable and unobservable differences between families defined
by husbands' health insurance status. We found evidence of frequent switching
by wives from non-participation or part-time work to full-time work in
order to acquire health insurance. In numerical terms, the estimates indicate
a 15--36% increase in wives' labor supply associated with a lack of insurance
coverage through their husbands.
Policy implications
In the past decade or so, state and federal policymakers have passed
several laws that make it easier for workers who leave insurance-providing
jobs to maintain their coverage. For example, in 1996 Congress passed
the Health Insurance Portability and Accountability Act (HIPAA), which
builds on both COBRA (Consolidated Omnibus Reconciliation Act) and the
state insurance reforms to further reduce the potential loss of insurance
associated with changing jobs. In general, HIPAA enhances access to coverage
by limiting insurer use of pre-existing condition clauses and screening
based on genetic or health factors, and by preventing insurers from refusing
coverage to individuals previously covered under a group plan who have
exhausted their COBRA coverage extensions (although insurers have wide
latitude in setting rates charged to individuals covered by HIPAA).
The evidence from the job lock and retirement studies cited above suggests
that these incremental insurance reforms have a substantial impact on
worker behavior. In particular, both job change and early retirement are
increased substantially by continuation of coverage laws. The exact economic
welfare effects of such changes have not yet been worked out. However,
continuation of coverage policies may improve economic efficiency by reducing
the distortionary impact of health insurance market characteristics on
labor market decisions. For example, Gruber and Madrian's (1997) finding
that wage gains resulting from job change are larger in continuation of
coverage states is consistent with this interpretation.
On the other hand, continuation of coverage laws enable older workers
to remain on their employer's plan after retirement, without any change
in cost. Because health care costs increase with age, this generates economic
inefficiency in the form of a subsidy from younger workers to older workers.
However, a recent policy initiative proposed by the current presidential
administration would enable early buy-ins to the Medicare system for individuals
aged 62--64 and displaced workers aged 55 and older, and continued coverage
for retirees aged 55--64 whose former employers have dropped their retiree
health coverage. This policy would reduce the subsidy from the young to
the old by requiring retirees to pay either Medicare premiums or a higher
premium than do other COBRA participants, although it has the likely drawback
of requiring transfers from general tax revenues for financing.
Finally, the labor supply analysis in Buchmueller and Valletta (1999)
suggests that universal coverage reform, although it may be desirable
for other reasons, may have unintended side effects. In particular, our
results indicate that policies that remove the linkage between health
insurance provision and full-time work are likely to reduce hours worked
by married women; this may be problematic if coverage is financed through
a payroll tax. The potential for such unintended side effects of policy
reform suggests a need for additional research on the linkages between
the markets for health insurance and labor.
Tom Buchmueller
Assistant Professor, UC Irvine
Rob Valletta
Senior Economist
References
Buchmueller, T.C., and R.G. Valletta. 1996. "The Effects of Employer-Provided
Health Insurance on Worker Mobility." Industrial and Labor Relations
Review 49(3), pp. 439-455.
______, and ______. 1999. "The Effect of Health Insurance on Married
Female Labor Supply." Forthcoming, Journal of Human Resources.
Gruber, J., and B.C. Madrian. 1995. "Health-Insurance Availability
and the Retirement Decision." American Economic Review 85(4)
pp. 938-948.
______, and ______. 1997. "Employment Separation and Health Insurance
Coverage." Journal of Public Economics 66, pp. 349-382.
U.S. Bureau of Labor Statistics. 1994. Employment Cost Indexes and
Levels, 1975-94. Washington, D.C.
Opinions expressed in this newsletter do not necessarily reflect
the views of the management of the Federal Reserve Bank of San Francisco,
or of the Board of Governors of the Federal Reserve System. Editorial
comments may be addressed to the editor or to the author. Mail comments
to:
Research Department
Federal Reserve Bank of San Francisco
P.O. Box 7702
San Francisco, CA 94120
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