group, again separating the currently sick from the currently healthy.) Insurers may also quote artificially low rates for the first year in order to gain new business.

One other rating practice that was once rare in the small group market but now appears to be gaining currency is some form of group-specific rating, especially for years after the initial year of the policy. Experience rating, in which premiums are based on actual costs for the particular group, is still uncommon in the small group market. However, some insurers may classify small employers into broad ranges, or tiers, by claim experience. A group with unexpectedly high costs during a year may be reclassed into a new, higher-rate tier.

Finally, employers who present the best risks may respond to annual rate increases by seeking a new insurer who will offer a more affordable first-year rate, a process known as churning. As a result, while insurers are competing more vigorously for the groups that present more favorable risks, their renewal business may increasingly consist of higher-risk groups unable to find a lower price. This spiraling process, which makes insurance less and less affordable for the higher-risk groups, has accelerated in the past decade.

Defects of Public Health Care Coverage

Government provides health coverage for lowincome people through the federal/state Medicaid program. Medicaid has accomplished a great deal: its enactment undoubtedly improved access to care for the segments of the poor population it has reached. But basic flaws in the design of Medicaid prevent it from covering many of those who need help. Some states have tried to fill in with other programs of their own. But funding limitations and other problems prevent these programs from helping most of the millions of poor people without health coverage.

Medicaid Medicaid provides coverage to about 26 million people who are aged, blind, disabled, or members of families with children. Each state designs and administers its own Medicaid program within broad federal guidelines. 17 The federal government pays an average of 55 percent of the cost of the program, a share that ranges from 50 percent to 80 percent depending on a state's per capita income. Combined federal and state expenditures for the program are expected to reach $70 billion in fiscal year 1990, just over half of which (55 percent) will go for hospital, physician and other acute care services. 18, 19

There are two reasons why so many low-income people do not get Medicaid coverage. An applicant not only must meet income and asset tests to qualify, but also must be in one of the protected populations defined in Medicaid law. Medicaid was designed to cover the welfare population-families with children receiving Aid to Families with Dependent Children (AFDC) and aged, blind, and disabled persons receiving Supplemental Security Income (SSI). Although current law defines some 40 different population groups potentially eligible for Medicaid coverage, either by federal mandate or under state option, all Medicaid beneficiaries must be aged, disabled, or members of families with children. Almost three out of four Medicaid beneficiaries are welfare recipients.

"Obtaining the benefits one is entitled to by law is not easy. It can be a time-consuming, complex, and demeaning journey. I have three documents here with me today.... One is an application for food stamps. It's 10 pages. On the second page of the application there are 38 questions. This is an application for [Supplemental Security Income] benefits. It is 15 pages long. I quit counting the questions at 100. This is an application for a $100,000 home mortgage. It's three pages long."

-Herb A. Sanderson, deputy director, Division of Aging and Adult Services, Arkansas Department of Human Services

Completely omitted from the program, even if they are literally penniless, are single people and childless couples who are under 65 and do not meet disability tests. And within the protected populations, Medicaid rules continue to use distinctions and exclusions carried over from the welfare programs. An intact, two-parent family headed by a full-time worker, for example, cannot be covered as a family. The children may be covered and the mother is eligible during the period of a pregnancy, but the father is never eligible.

Along with these complex categorical exclusions go enormous variations in the financial standards im

posed by the states. For many of the eligible groups there are no minimum federal standards. A family of three in California could get Medicaid in 1990, for example, with a monthly income of up to $934, about 106 percent of poverty. The same family could get Medicaid in Alabama in 1990 only if its income was $118 a month or less. This cutoff is just 13 percent of poverty.21 Further aggravating the disparities, many states fail to adjust their financial standards adequately to reflect inflation, making the real standards more restrictive over time. The median state AFDC payment level, which determines family Medicaid eligibility

The consequences of having no insurance can be devastating. Diana and Melvin Seeger of Grand Rapids, Michigan, know this only too well.

M MORI L
MORIAL
SPITAL

Diana Seeger could not qualify for Medicaid or afford care at a hospital close to home; her baby sustained brain damage at birth.

Mr. Seeger's job as a logger did not provide insurance. And, although he earned just $9,000 a year, the couple's assets made them ineligible to qualify for medical assistance. So Mrs. Seeger couldn't afford to go to either of two hospitals within 20 minutes' drive of their home for the delivery of their third child. Instead, they chose a more affordable hospital an hour and a half away.

On their way to the hospital, Mrs. Seeger went into labor shortly after leaving home. The couple wound up at an Indian out-clinic unequipped to handle deliveries. The baby was deprived of oxygen and as a result was severely brain damaged.

After spending most of his first year in the hospital, their son David was released to medical foster care. Rehospitalized several times for surgery, David died when he was three and a half years old. "It's really tragic," Mrs. Seeger told the Commission. "Had we had health insurance or been eligible for medical assistance, we could have gone to a closer hospital, and David would be alive today."

Small firms, regardless of their line of business, also face an additional barrier to coverage: medical underwriting, or the practice of designing plans according to the medical history of the potential enrollees. For groups of fewer than 10 or 15 workers, an insurer may require medical information about each employee. If some members of the group are determined to present high risks, the insurer may follow any of a number of courses:

• The whole group may be denied coverage, • The insurer may offer coverage to the group only if the high-risk employees are excluded, • The insurer may permit the inclusion of these employees but increase rates to the entire group.

Even if the group is not determined to be especially high risk, other limitations may apply. The policy may exclude coverage for preexisting conditionsproblems that were already diagnosed at the time the policy took effect but that may not have been known to the insurer-or it may impose a waiting period before coverage begins. Another limitation is to offer coverage only on a nonguarantee issue basis, meaning that the insurer makes no guarantee that it will offer the same policy to the group when the contract expires. Many small group policies also require minimum participation levels to guard against the possibility that only the higher-risk, more costly employees will participate. For the very smallest groups the policy may stipulate that 100 percent of eligible workers must enroll. To achieve these participation levels, employers must limit the share of premiums paid by the employees themselves to make the plan affordable. Very small employers may even be required by the terms of their policies to pay the entire premium.

Small employers who clear all these hurdles and obtain health coverage are still likely to pay 10 percent to 15 percent more than larger groups for an equivalent plan. This difference is generally not attributable to differences in the cost of benefits, but to the higher administrative costs involved.

For the smallest plans (one to four employees) administrative expenses can equal as much as 40 percent of claims. They drop to 35 percent for groups of five to nine, 30 percent for groups of 10 to 19, and 25 percent for groups of 20 to 49. Total administrative expenses of the largest conventionally insured plans (10,000 and more employees), by contrast, average 5.5 percent of claims. In self-insured plans, which are generally not an option for small employers because they are too small to take the risk, administrative costs can be as low as 2.5 percent of claims. 15

In addition to general overhead items, which are fixed and therefore have to be spread over fewer enrollees, certain cost components are especially likely to be higher for small groups. The first is the commission paid to the insurance agent or broker who sells the policy. This averages 8.4 percent of claims for a group of fewer than five enrollees, and less than 1.0 percent of claims for groups of 500 or more. A second is the risk or risk and profit charge, which includes both the insurer's profits and some cushion against unexpectedly high claims cost. The risk charge averages 8.5 percent for groups of fewer than five, in sharp contrast to 3.5 percent or less for groups of 500 or more.16 Small groups face higher risk charges in part because costs for these groups may be

less predictable than for larger ones. But smaller groups also pay a higher risk charge because of their limited bargaining power.

In addition to facing higher initial costs for coverage, small employers sometimes find that their premiums increase sharply after the first year of coverage. A group may start out with a healthy pool, since the group members with a known, immediate need for health services have been excluded. Over time, however, those left in the pool will gradually use medical care at higher rates, leading to increasing costs claimed under the policy. Accordingly, many insurers raise the rates after the first year of the policy. (Some may offer, as an alternative, to re-underwrite the

Small firms, regardless of their line of business, also face an additional barrier to coverage: medical underwriting, or the practice of designing plans according to the medical history of the potential enrollees. For groups of fewer than 10 or 15 workers, an insurer may require medical information about each employee. If some members of the group are determined to present high risks, the insurer may follow any of a number of courses:

• The whole group may be denied coverage, • The insurer may offer coverage to the group only if the high-risk employees are excluded, • The insurer may permit the inclusion of these employees but increase rates to the entire group.

Even if the group is not determined to be especially high risk, other limitations may apply. The policy may exclude coverage for preexisting conditions— problems that were already diagnosed at the time the policy took effect but that may not have been known to the insurer-or it may impose a waiting period before coverage begins. Another limitation is to offer coverage only on a nonguarantee issue basis, meaning that the insurer makes no guarantee that it will offer the same policy to the group when the contract expires. Many small group policies also require minimum participation levels to guard against the possibility that only the higher-risk, more costly employees will participate. For the very smallest groups the policy may stipulate that 100 percent of eligible workers must enroll. To achieve these participation levels, employers must limit the share of premiums paid by the employees themselves to make the plan affordable. Very small employers may even be required by the terms of their policies to pay the entire premium.

Small employers who clear all these hurdles and obtain health coverage are still likely to pay 10 percent to 15 percent more than larger groups for an equivalent plan. This difference is generally not attributable to differences in the cost of benefits, but to the higher administrative costs involved.

For the smallest plans (one to four employees) administrative expenses can equal as much as 40 percent of claims. They drop to 35 percent for groups five to nine, 30 percent for groups of 10 to 19, and 25 percent for groups of 20 to 49. Total administrative expenses of the largest conventionally insured plans (10,000 and more employees), by contrast, average percent of claims. In self-insured plans, which are generally not an option for small employers because they are too small to take the risk, administrative costs can be as low as 2.5 percent of claims.

15

5.5