Many opponents of Obamacare claim that large employers will drop employee health coverage in droves. The Wall Street Journal has made this argument a centerpiece of its opposition to the health exchanges. The argument has some face validity – employers that drop coverage can save about $10,000 per employee in insurance costs but only have to pay fines of $2000 per employee. What employer would not want to save $8000 per employee?

Supporters of Obamacare argue that if employers do not pay for insurance, they will have to increase wages. This will temper the incentives of employers to drop coverage. This follows from a classic model in labor economics that says that employers have to give workers a competitive wage/benefits bundle, and that the mix of wages and benefits is largely fungible. Thus, if benefits fall by $10,000, wages will increase by about the same amount. The theory is well accepted.

While it has been difficult to construct empirical tests of this theory, the available evidence is largely supportive (though the evidence of 1:1 fungibility is less compelling than the evidence of some degree of fungibility.) This may explain why the Congressional Budget Office predicts that only a few million workers will lose their employer sponsored coverage and get pushed onto the exchange. Even so, the Wall Street Journal and others have dismissed this theory and evidence, arguing that employers who drop coverage will pocket the full savings and therefore than tens of millions of workers will be affected.

I want to propose a simple test of the naysayers’ position. The test relies on evidence that the Wall Street Journal and others should find unimpeachable –stock market valuations. This is a quick and dirty test but the results are so compelling that I think it is sufficient.

I rely on some basic labor market data. Consider that American firms pay workers about $60,000 annually in average compensation and benefits. Moreover, these labor expenses represent about two-thirds of the total cost of production. Now suppose that firms can reduce their wage/benefit package by $4000 by dropping $10,000 in insurance coverage, paying a $2000 fine, and increasing wages by just $4000. In other words, I am supposing that there is 0.5:1 fungibility between wages and benefits. (I get similar qualitative findings with any ratio that is substantially less than 1:1, as the naysayers are assuming.) This savings reduces total compensation costs by 6.7 percent and therefore reduce total production costs by 4.4 percent. In effect, this simple move would increase returns on sales by 4.4 percent! This would effectively double the average return on sales for U.S. manufacturing firms (which is currently about 5 percent) and represent an even bigger increase in retail and other industries.

If the naysayers are correct, then the passage of Obamacare should have had a remarkably powerful impact on the stock market. Share values should have doubled and then some! And the effect should have been immediate, as investors could have performed the same math as I have just done and seen the good times ahead. Of course this did not happen. I can only conclude that investors did not and do not expect large employers to reap a windfall from Obamacare. Large employers that drop coverage will have to increase compensation to workers to make up for the difference. Obamacare does not provide a free lunch to employers, and this is why the CBO and others expect such a small impact on employer-provided coverage.

What I find most remarkable is that the Wall Street Journal is a staunch believer in free markets, yet it conveniently ignores market mechanisms when it wants to make a political point.

David Dranove, PhD, is the Walter McNerney Distinguished Professor of Health Industry Management at Northwestern University’s Kellogg Graduate School of Management, where he is also Professor of Management and Strategy and Director of the Health Enterprise Management Program. He has published over 80 research articles and book chapters and written five books, including “The Economic Evolution of American Healthcare and Code Red.” This post first appeared at Code Red.

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23 Responses for “Will Obamacare Drive Out Employer-Sponsored Insurance?”

  1. steve says:

    While I tend to agree with this, I am not sure the market always looks that far out (though it should by now). The Massachusetts model is also a good reference.

    Steve

  2. Paolo says:

    This is an excellent article!

    It never ceases to amaze me how the more extreme and vocal supporters of the free-market have no problem making predictions that are in complete opposition to what the free market is actually predicting. Another example is the large number of people that have been predicting for years that hyper-inflation is around the corner, while TIPS have negative yields.

    Employers won’t drop insurance just because they are legally allowed to do so. Pre-ACA, they are already legally allowed to drop insurance, or lower your wages, or make you work longer hours, or make you do unpleasant work. They don’t do so because the employment market is free and competitive, forcing them to adequately compensate you based on your market value.

    Employers will continue offering health insurance because of the tax exclusion. The after-tax value of $10,000 compensation going to health insurance is higher than $10,000 compensation going to salary. This is particularly true for employees in higher tax brackets.

    If one day the tax exclusion is phased out (or a similar tax deduction is created for individual policies), then employer-based insurance will start eroding away. Personally, I think this would be a good thing. Most people don’t want to depend on an employer for health insurance any more than they want to depend on an employer for food or shelter.

    • leo says:

      Agreed. The whole notion of employer-based insurance is anti-freedom and stifling the job market. How many people are not in their ideal job because they don’t want to lose insurance? How many people have chosen not to start their own business (or stayed in a bad marriage for that matter) because of employer-sponsored insurance? We need something that makes a lot more sense.

  3. Tim says:

    “This savings reduces total compensation costs by 6.7 percent and therefore reduce total production costs by 4.4 percent. In effect, this simple move would increase returns on sales by 4.4 percent! This would effectively double the average return on sales for U.S. manufacturing firms…”

    Uh, no. What amazes me is how critics of market advocates simply cannot grasp how markets work.

    You can’t just assume that a drop in costs automatically adds to profits. If costs drop by 5% across an industry, then non-colluding firms in the real world will begin inching their prices down to capture market share. Competitors will respond, and profits will squeeze out till capital begins to seek a higher return elsewhere. All else being equal, a drop in costs alone has little to do with profit levels.

    By the way, advocates of free market solutions do not believe that stock markets are infallible. We simply believe they are what they are, which is the best mechanism available for setting a market-clearing price on a company. And that’s all. As such, they represent a partially rational view of expected earnings.

    Markets are morally-neutral machines, not oracular voices from a delphic cave. Just because the “stock market” likes something (or not) means little by itself.

    • Paolo says:

      In a competitive industry with no collusion, wages and compensation are determined by the same free market mechanism as product prices. Compensation will not be reduced unless there is a change in market forces. It’s disingenuous to claim that companies somehow have the market power to cut compensation by a huge amount, while not having any market power to keep any of the cost savings in the form of profits.

      • Nate Ogden says:

        What industry are you referring to that has no mobility to other industries? Majority of our work force is not so specialized that they wouldn’t leave HVAC to go to Tool and Die.

        Wage and Benefits are far more global then prices.

        If your HVAC employer eliminates your health insurance and doesn’t increase your wages you leave to go work for another HVAC company. Summer repairs start to call in if you don’t have the employees you can’t take the calls and they go to the competitor who has all your ex employees.

  4. Tony says:

    In some sectors of the health care industry, there is a talent shortage. Not providing health insurance, while it may seem economically beneficial, is likely to have a negative impact on highly talent employees who may choose to move to a company that has a better total overall compensation package, We see companies unable to realize their growth potential because they can’t find the necessary talent to grow. It is hard for us to believe that growth oriented companies will stop offering health insurance.

  5. Barry Carol says:

    Ben Graham, co-author of the famous finance text book, “Security Analysis, Principles and Techniques,” taught us a long time ago that in the short term, the stock market acts as a voting machine and is heavily influenced by psychology and emotion as well as business fundamentals. In the long term, though, it acts as a weighing machine and ultimately accurately reflects the intrinsic value of the enterprise relative to other investment alternatives available at the time.

    As for health insurance, 99% of employers with 200 or more employees currently offer it while the percentage is much lower for smaller firms. The companies most likely to stop offering health insurance when the exchanges become available are those that employ many low wage workers in industries like restaurants, retail trade and hospitality. Where and when the economy is weak, employers don’t have to pay as much in total compensation to attract qualified people as they do where and when it’s strong. To the extent that they are successful in reducing their labor costs by no longer offering health insurance and not increasing wages by a comparable amount, any cost savings are likely to be competed away over a reasonable timeframe in order to either grow or at least sustain their market share.

    Even companies that employ highly educated workers could do a much better job of making them aware of the value of their employer provided health benefits by telling them just how much the employer is spending on employees’ behalf for insurance premiums. Most employees don’t have a clue, especially those with the most generous benefits. If they knew how much the employer was spending and that this is a key part of their total compensation, they may be inclined to trade away some of their health insurance benefits for other tax preferred benefits like a higher 401-K matching contribution or, perhaps, more vacation time or even a taxable wage increase.

    • Nate Ogden says:

      Specifically low wage employers that have low participation will jump out quickly. They are already being adversely selected against. If your going to pay a fine on 40% of your employees not taking coverage why not drop it all together and pay the fine on everyone. The only people that appreciate the benefit in those cases are the very sick employees which are the same ones driving cost above the affordable level.

      We have been telling groups with low participation they need to fix the problem now and get a good 12 month picture of their risk profile before 2014.

      High cost plan and tax bill is double loser.

    • Paolo says:

      If a company or industry is doing poorly, total compensation will invariably go down, whether it’s in the form of wages or benefits. But when an industry is stable, total compensation is stable as well. A law like the ACA may trigger a change in the type of compensation (from health insurance to wages or pension), but not the total compensation. Total compensation is set by the market.

      • Nate Ogden says:

        “Total compensation is set by the market.”

        But in most cases is not limited to industry. A clerical person in the auto industry can leave and go do clerical in any other industry. A cashier in retail can go cashier in fast food.

  6. Raymond says:

    Employer-provided healthcare is an old idea whose time has passed. We need to transition from employer-funded insurance to individually-purchased and managed insurance ( just like car and home insurance ). Perhaps the current employer contributions can be deposited into an HSA account ( per-tax ) where the employee can then use it for any health-related expense, including purchase of Insurance.

    On the flip side, when you show up to a hospital or a doctor’s office, if you can not pay their fees, they should NOT be required to provide free care. Let the Republicans who claim that Obamacare is violating their FREEDOM agree that if they show up with no ability to pay, they would be allowed to die ( it is their freedom of choice not to have insurance, and mine not to foot the bill for their carelessness !!! )

    Add to this the idea of ‘insurance pools’ ( or exchanges ) where individuals can get together ( perhaps by neighborhood associations or other community groups ) and purchase insurance just like a company would, and we would have an American Free-enterprise Individually-controlled Healthcare system !! EOD !

    • Nate Ogden says:

      “Employer-provided healthcare is an old idea whose time has passed.”

      Why? What about it is no longer efficient or needed?

      “We need to transition from employer-funded insurance to individually-purchased and managed insurance”

      Why? It is cheaper to sell 30 million policies then it is to sell 300 million. Do you have any clue what the increased cost would be for the 100,000 employees of CAT to all go buy individual policies? Are you trying to waste money and be less efficient?

      If everyone is going to have HSAs what is the advantage of an individually purchased HSA over a considerably more efficient employer purchased HSA?

      “Let the Republicans who claim that Obamacare is violating their FREEDOM agree that if they show up with no ability to pay, they would be allowed to die”

      Need to pull your head from your backside. It’s liberals that have issue with this not republicans.

  7. Nelle Polhamus says:

    Well, you can contact them and ask them about it first off.

  8. DHF says:

    While the logic is sound, the proposed test is only (somewhat) compelling if the market actually believes that the healthcare legislation is going to remain the law of the land.

    The lack of a market response could simply be reflecting the uncertain legal standing of the healthcare legislation.

  9. Ann says:

    I want to know the REAL truth. WHO gets the money from the fines? Is it more money for the government slush funds? WHO gets all this fine money? Certainly, not the people who are being hurt. How about passengers sitting on a runway too long? The airline is fined. Do the passengers who have been getting so inconvenienced receive the fine? NO, apparently it goes once again to the ‘government’. Follow the money trail . . . dismantling the private health care system PLUS the government getting a windfall during the process may be the whole reason behind Obama-not care.

  10. Gregg says:

    Anyone who argues that the Affordable Care Act (a.k.a. Obamacare) will cause employers to drop healthcare for their employees is ignoring one key fact:
    There is no requirement for any employer to provide healthcare to its employees today! Yet many large employers do so anyway.

    So the argument that the option to “buy out for a fine” will cause them to drop employee coverage doesn’t make sense – they could drop their employee insurance coverage TODAY without any fine whatsoever. So to believe that the ADDITION of a $2000-per-employee fine will cause employers to drop coverage when they haven’t already dropped it today without a fine makes no sense.

  11. larry says:

    my employer is going to reduce wages…and increase my cost for benefits. If they were to drop insurance…they could/would pocket the difference.

  12. John Arceneux says:

    A major reason large companies like the current system is that it makes employees more endentured. What large company wants to make it easier to change jobs? health insurance is a powerful tool to lock an employee into a position they could likely get more money for (and far more job satisfaction) at a small startup.

    in addition, some companies that are large enough to self-insure actually make money off their emplyee’s health premiums.

  13. Mark says:

    You people trumpting that as companies don’t have to provide health care now, they will still want to do it after the bill goes into affect do not understand the world they live in. Companies offer it as a employment incentive and to keep their work force healthy. If the government does this they have every reason to drop employees. Also there is NOTHING in the bill or elsewhere that says they have to increase your compensation and with the poor employment market currently available there is no competition to push them that direction. Finally, I didn’t take you to raise so pay for your own stuff.

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