Cost and Performance: A Comparison of the Individual and Group Health Insurance Markets

The great bulk of private health insurance in the United States is obtained in employment-based groups, but this institutional structure has recently been subject to criticism for its apparent failure to achieve the social objectives of widespread and satisfactory coverage. One common criticism notes a continued erosion of the proportion of the relevant population covered by this form of insurance--an erosion that slows but does not stop in periods of tight labor markets and that is correlated with a rise in the overall proportion of the population that is uninsured. In addition, there is bipartisan criticism of the types of coverage employers have been offering, as they move more and more to managed care of some form.

In the face of these problems, there has been renewed interest in the nongroup or individual health insurance market. Most obviously, that market allows individuals to choose the form, type, and generosity of insurance themselves, without limitation, selection, prescreening, or channeling by employers and their benefits managers. The number of different health plans available to a buyer in the individual market (assuming acceptable premiums and underwriting) is in the hundreds, many more options than exist in even the broadest group arrangements, such as those available to federal employees. Managed care plans are less dominant in the individual markets, and more of the plans offer the free-choice features common in indemnity or even "managed indemnity" offerings.

Another advantage of individual insurance is that, in contrast to those with workplace insurance, people with individual insurance need not be concerned with losing or changing their insurance because they change jobs or because their employer redesigns or reduces benefits. When people have their own health insurance, it is almost perfectly portable and highly adaptable to their demands and tastes. (Because some individual policies are offered by insurers that only operate in one or a few states, however, portability may not always be nationwide.)

In contrast to the attraction of more portability and freedom of choice, there is apprehension that individual insurance enrollment may also be responding to some trends in group insurance: the premium for group insurance paid directly by the employee (and avoided if coverage is refused) has been rising, and a larger proportion of employees offered coverage are choosing to reject it for whatever reason. Low-risk (especially younger) workers could find choosing individual coverage preferable to group insurance if they are required to pay the same total group insurance premium as older workers; the result would be departure of low risks from the group pool.

Another less favorable, though important, aspect of individual coverage--which may deter insurance purchase by those not offered group coverage--is that individual insurance is believed to be much more costly (per dollar of expected benefits) than group insurance. First, the administrative expense or "loading" percentage for such insurance is believed to be much higher than for group insurance, at least for medium and large groups, primarily because it is more expensive to sell and bill for insurance on a one-on-one basis than to a single group decision maker. Second, there are tax advantages for employees whose group premiums are paid as part of employee compensation. These are not available for individual insurance, which can only be shielded from income tax, not from payroll tax, and only by the self-employed or by those with very high medical expenses. Partly as a response to this high net administrative loading, buyers of individual policies tend to choose less generous coverage.

In summary, the policy issue here involves trade-offs between greater choice, high portability, and stability of coverage on the one hand, and both higher administrative cost and less risk spreading on the other hand. In this article we provide some descriptive information that bears on...