Experience-Rating

The employee group is “the most effective mechanism for pooling of health insurance risks in the private health insurance market.”[1]  The original health insurance plans, Blue Cross and Blue Shield, used a mechanism called community rating to price premiums.  This meant that the “Blues” charged the same premium to each policyholder within a given community, spreading costs evenly amongst the healthy and sick regardless of age, gender, health status, or any other characteristic that can increase risk.  Once the Blue Cross and Blue Shield plans established employment-based provision as an institution, commercial insurance companies realized the profitability of the market.  In order to compete with the already established “Blues,” commercial insurance companies introduced the use of experience rating as a means of determining cost distribution.

Experience rating prices insurance policies using groups of varying size, usually the employee group of a given company, with varying levels of risk.  Premiums are determined based on an assortment of characteristics of the company, such as the industry, average age, gender composition, as well as the company’s actual medical costs.  The practice dates back to the early days of workers’ compensation insurance when insurers realized that different occupations presented differing levels of risks to their employees, pricing premiums accordingly.  The commercial insurers realized that they could compete with the “Blues” by offering low-risk groups better rates.

Experience rating solidified the connection between employment status and health insurance.  Despite organized labor’s belief in a national health plan, unions in particular came to benefit from the system of experience rating to reduce their health care costs.[2]  Unfortunately, this system also raises costs for the portion of the population that remains in the community rated model, because costs are no longer shifted onto the low-risk, low-cost population.  Smaller groups have less room to spread costs, and are particularly vulnerable when an individual member of that group requires care.[3]

Self-Insuring

An employer can choose to self-insure their employees’ health needs, which means that the financial risk for the employees’ medical costs is assumed by the employer rather than an insurance company.[4]  Employers can offer benefit packages designed for the specific needs of their employees rather than a generic insurance plan.  Self-insuring reduces cash-flow demands on a company and allows employers to invest funds from premiums rather than paying them to an insurance company.  It is estimated that 65 percent of employers who offer health benefit plans self-insure, either partially or entirely, rather than purchase insurance.[5]

After ERISA was enacted in 1974, self-insured plans were declared exempt from state regulations, including state mandates on benefits, mandatory participation in state risk pools, and state taxes on insurance premiums.  As with labor unions, the ERISA exemptions facilitate multi-state employers, because it enables them to have uniform health plans regardless of the insurance laws for each state in which the company operates.[6]  Since ERISA was enacted in 1974, only the federal government can pass legislation relating to health benefit plans, and the federal government has preferred to leave them largely unregulated

The Consolidated Omnibus Budget Reconciliation Act of 1985, or COBRA, Is one of the few federal statutes.  It requires employers of greater than 20 employees to continue health benefits for former employees and their covered dependents for 18 to 36 months following termination of employment, or until a new plan begins.  COBRA essentially required group coverage to be available—though not subsidized—during transitions in employment to avoid gaps in coverage.[7]  The Health Insurance Portability and Accountability Act of 1996 limits specific exclusions from coverage, such as those relating to preexisting conditions, and imposed guaranteed renewal and portability requirements on small group and individual plans.  Congress also imposed two specific benefits mandates: minimums on length of stay for hospital maternity care and parity for mental and physical services.[8]


[1] Uwe E. Reinhardt, “Employer-Based Health Insurance: A Balance Sheet,” Health Affairs (November 1999-December 1999).

[2] Bodenheimer et al., 7-8, and Institute of Medicine, 72, and Gottschalk, 57-58.

[3] Milt Freudenheim, “Fewer Employers Totally Cover Health Premiums,” New York Times, March 23, 2005, C1, and Seifert et al., 10.

[4] Seifert et al., 18.

[5] Polzer et al.  Seifert et al. suggest the ratio is somewhere between one-third and one-half, 19.

[6] Institute of Medicine, 83, 111, and Seifert et al., 19.

[7] Institute of Medicine, 85.

[8] Polzer et al., and Seifert et al., 19, 29.

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