Should Individual and Group Insurance Receive the Same Tax Subsidy?
By John Goodman Filed under Uncategorized on April 15, 2008 with 18 comments
Tax law favors employer-provided group insurance and discriminates against individually purchased insurance. Should that inequity be corrected? What follows is a blogosphere debate, edited by yours truly.
Individual health insurance always leads to guaranteed issue, due to insurability issues, and this always leads to mandates, which always lead to increased premiums, which inevitably lead to government medicine.
Assuming people could get a tax credit/deduction for obtaining insurance outside of an employer, I think the ability of individuals to buy health insurance would be very useful to the market. I agree that mandates, guaranteed issue and the rest should be avoided. However, I would like to see a strong market for individual purchase of health insurance.
David:
Individual health insurance is a good thing, but here’s the problem right now. In 45 states, individual health insurance is fully underwritten. Some states are allowed to place riders on policies to exclude certain conditions for 6 or 12 months, while states like California cover everything with no limitations, once the policy is approved. Because of this California has a very high decline rate.
If California were to dump employer sponsored coverage for individual insurance tomorrow, it wouldn’t be long before people would start screaming about “cherry picking.” This would likely lead regulators to call for guaranteed issue and community rating. Guaranteed issue drives costs through the roof due to adverse selection, so it is a natural precursor to an individual mandate, albeit an unenforceable one. The next step is “universal coverage” or government medicine.
Group insurance offers many advantages, including the ability to pool and partially self fund. HRA’s also save employers lots of money, which is why four carriers in California are trying to prevent employers from using HRA’s.
What we need is a conversion product which is better than COBRA. A guaranteed conversion to the individual market, with subsequent migration back to group when the employee gets another job.
Ralph:
Your hypothetical — “If California for example were to dump employer sponsored coverage for individual tomorrow” — is as unlikely as anything I can think of. It’s simply not an issue. What IS an issue is that employees whose employers choose not to provide coverage are screwed by the tax code through no fault of their own. That is something we can and must fix ASAP.
Ralph Weber makes sense and we certainly need a “transition process.” If we just equalize the tax bias tomorrow, young and healthy workers would go into the individual market leaving the old and sick in the employer-sponsored plans. A death spiral would soon cause employers to stop offering coverage. Then we’ll have millions of middle-aged workers thrown into an underwritten individual market that they cannot afford. If you talk with Republican politicos, this is one thing they fear and it is why they do not work hard enough to eliminate the tax prejudice.
My own thought (which I have not scored) is that the death spiral is unavoidable and beneficial (don’t tell the US Chamber of Commerce I said this!) so we need to “score” a subsidy that will be available for, say, a two-year period after the tax reform for which people can apply. After that, you’re on your own and responsible for buying guaranteed-renewable health insurance when you are young & healthy.
I haven’t written on this with precision because I am not sure whether the tax bias would result in the individual market dominating or people buying through non-employment-related groups, e.g. alumni associations, churches.
Not so. All employers pay half the premium and the average employer pays 75%. So under a McCain type level playing field, an employee would not opt for an individually purchased plan with the same benefits unless it costs less than 25% of the cost of group insurance. If a group plan is that much overpriced it should be put out of business.
That’s right, John. Most employers have a business reason for providing benefits. That reason does not disappear if the tax code for individuals is equalized.
There is one exception to this, and that is that employers usually use community rating within their company. So the 25 year-old novice is paying the same premium as the 55 year-old executive. The 25 year-old might find it cheaper to pay full premium in the individual market rather than to pay his share of the same premium the 55 year-old pays. The lesson here is that employers should NOT use community rating. Each employee should be assessed a premium share based at least on their age.
True, but more and more employers are paying 25% or less of dependent’s coverage, and in 44 States, individual insurance costs less than group insurance, and offers more options. In most cases the employee is better off purchasing individual coverage for his dependents, than paying the premium through an FSA….or if the tax credit goes through, than paying it straight up.
May I continue the volley by suggesting that if tax prejudice is erased, employers who offer group coverage splitting the cost 75% / 25% will soon become uncompetitive at hiring a certain type of highly desirable worker: young, well-educated, energetic employee who’d prefer to take the money and run to the individual insurance market – if that market were robust, guaranteed renewable (with some way to fix the closed-block problem; I’m not fully satisfied with the American Academy of Actuaries 2004 paper advocating high-risk pools), and he could keep the policy for life.
Also, some states automatically give you an aggregate rate, and some give you age banded rates. I prefer age banded.
I appreciate the points about the difficulties in expanding the individual insurance market and the potential negative effects. Nevertheless, there is a need for individual purchase of insurance and I hope that it can be promoted by tax credits (refundable for some) and tax deductions for all (not just through employers…which should end). For instance, my mother who is now 64 has been spending between 10-12k/year for her insurance for many years and it is a huge burden with no tax deduction (she is buying on the individual market).
Interesting that most of the commentary is based on expanding the insurance deduction to the individual market. Just to play Devils’s Advocate, has anyone considered the impact of eliminating the overall tax deduction or paring it back to some lower expenditure? Per a previous post of mine, it appears more than $200B in subsidies exist today
As a small employer, I’ve decided that for my employees, the tax benefits of offering health insurance don’t add up as a substitute for wages/equity. Instead, I’m allowing employees to buy their own policies, and if they choose a HSA, I contribute a significant portion of the allowable annual contribution. This keeps me to a defined contribution and allows employees the ability to pay into premiums as they choose…removing me from the insurance headache and promoting the marketplace for retail/cash pay health (which my startup company is trying to expand).
Attempting to create equality of individual and group insurance through the tax code misses the entire point. The way to make individuals equal to groups is to expand the definition of groups under state law – as you are aware, federal law has very limited impact on insurance – ERISA could be expanded as it now favors government entity, multi-state employers and unions. Actuaries and underwriters can more easily and correctly assign rates to groups not individuals. They seek large numbers, not individuals. Give the individuals the freedom to choose to belong to a group of their choice. Guaranteed issue is assured. Pre-existing condition limitations can competitively be offered to be waived and employees will no longer be burdened with their misbelief that they need to be stuck in a dead end job in order to keep their health insurance.
What to do with the tax code makes for a nice discussion, but does not address the root of the inequality between individual and group insurance.
Sadly, the entrenched stakeholders – the 30+ elected state insurance commissioners, the 50 Attorneys General and the single and smaller multi-state Blue Cross Blue Shield plans – all stand to lose the most. The U.S. Senate has not had the will to change the ERISA laws to expand the number and types of eligible groups. The House passed some bills to address this without success.
John,
I think that small business owners could greatly benefit if they were to receive a tax break on individual policies. They are much less expensive than group plans, mainly because as you know they are medically underwritten, where group is guarantee issued. This could really reduce costs for the small business owner. I see many “mom and pop” business owners of 2 lives apply for a group plan simply because they are unable to obtain an individual policy, or to get immediate maternity coverage.
Employers provide or “want” to provide coverage for two reasons only… to RECRUIT and to RETAIN employees. Many employers who want “out” of providing group insurance simply cannot do so, because their competition will continue to provide it and employees will leave/opt for the employer that provides benefits (all things being equal).
Most of my clients have been through the excercise in terminating group plans and giving $$$ for individual coverage, UNTIL they realize that there are oftentimes at least one or more employees who will NOT qualify for individual coverage.
As we move from wholesale (employer provided coverage) to a retail (individual) in this market… many things will need to change. I don’t see the need to set a prerequisite for employers to be denied a deduction for health premiums paid, but certainly employees should benefit from the same decision if made personally.
There should certainly be a comparable tax break for individually-purchased group insurance, but individually-underwritten insurance is another matter. If one of the criteria is to give equal treatment to purchasers of group and non-group insurance, then the tax breaks would have to be different for the two classes of insurance.
With employer-provided group insurance, the lowest-risk individuals don’t actually get much of a subsidy. The tax exclusion merely offsets the cost to these individuals of subsidizing high-risk members of the group. Only higher-risk employees receive a net subsidy, in the form of a combination of tax exclusion and lower-than-underwritten premium.
So to design a fair tax credit for individually-underwritten insurance, only the portion of the premium in excess of the preferred rate could qualify for the credit.
For individually-purchased group insurance, tax treatment could be closer to what we already have with employer-provided insurance. Assuming the group plan uses modified community rating (age-banding), then the credit (as percentage of premium) could be fairly modest and still make group coverage attractive to healthy individuals.
DEPARTMENT OF MENTAL HEALTH COULD BE PRACTICALLY ELEMINATED BY: WINDHORSE ASSOCIATES-ORIGINALLY FROM COLORADO: NOW ALSO,OUT OF NORTHAMPTON, MA: WHERE CHRONIC MENTAL ILLNESS IS 98% WIPED OUT. WINDHORSE TEACHES THE PERSON HOW TO AVOID HAVING RELAPSES-
THEY DON’T RELY ON DRUGS TO HOLD A PERSON TOGETHER !!
WASHINGTON NEEDS TO KNOW THE TRUTH
Perhaps I read this discussion too quickly, but it seems to me that the real point of reform is missed. I think that it relates to the need to make employees more aware of the costs of their medical treatments and thus their insurance premiums and more determined to reduce them. If one has to pay for treatment or insurance with dollars out of one’s own pocket gained through salary one is more likely to ask about real costs than if one pays for it with money that one never sees. If we required all to pay for insurance with take home pay we might see more attention to costs.