The Senate Finance Committee hosted a huge panel of experts yesterday to discuss health insurance. The best testimony was given by Dr. Kate Baicker of Harvard, a former White House colleague of mine. I highly recommend you read anything Kate writes. I will crib from her testimony to link three concepts that I think mutually reinforce to contribute to our national problem of exploding health care expenditures. All three concepts fit under the umbrella of third-party payment — people spend more of other people’s money than they do of their own, and less wisely.

Here are the three concepts:

  1. There is a tradeoff between employer-provided health insurance and wages. Health insurance provided by an employer looks less expensive to the employee than it is.
  2. The tax code distorts compensation decisions away from wages and toward expensive health insurance.
  3. Low-deductible health insurance encourages over-utilization of medical care.

I will take these one per day. The first one is the easiest.

Here is Kate on the first concept:

Employees ultimately pay for the health insurance that they get through their employer, no matter who writes the check to the insurance company. The view that we can get employers to shoulder the cost of providing health insurance stems from the misconception that employers pay for benefits out of a reservoir of profits. Regardless of a firm’s profits, valued benefits are paid primarily out of workers wages. While workers may not even be aware of the cost of their total health premium, employers make hiring and salary decisions based on the total cost of employment, including both wages and benefits such as health insurance, maternity leave, disability and retirement benefits. They provide health insurance not out of generosity of spirit, but as a way to attract workers  – just like wages. When the cost of benefits rises, wages fall (or rise more slowly than they would have otherwise), leaving workers bearing the cost of their benefits in the form of lower wages.

I’m going to create an example family, Charlie and Kelly Thompson, and their son Fred. In 2008 Kelly earned $60,000 per year, and Charlie $20,000, providing an annual family income of $80,000, which put the Thompsons near the top of the third quintile — their income was greater than that of about 60% of similarly-sized American families, and less than the other 40%.The Thompsons got a typical family health insurance policy through Kelly’s job. Their total premium cost was $12,000 in 2008.Kelly’s employer paid $9,000 of that premium, and the Thompsons paid the other $3,000 out of pocket.

Today I’m going to ignore the tax exclusion for employer-provided health insurance and just focus on the first point. To be clear, the numbers I use here are incorrect, in that they ignore a major distortion from our tax code. I will introduce that distortion tomorrow.

I want to focus on how Kelly is doing this year, relative to last year, and compare what she sees with reality.

Here is what Kelly’s employer saw in 2008:

2008
Total amount I can afford to employ Kelly $69,000
minus 3/4 of Kelly’s $12,000 health insurance premium – $9,000
equals Kelly’s salary = $60,000

Here is what Kelly sees in 2008:

2008
My salary $60,000
minus 1/4 of my $12,000 health insurance premium -$3,000
equals my salary after paying for health insurance = $57,000

Kelly’s employer thinks, “It’s costing me $69,000 to employ Kelly in 2008.” Kelly thinks, “I’m getting $57,000 plus health insurance in 2008.” Since Kelly thinks her health insurance costs only $3,000, there is a huge ($9,000) perception gap. You can see the tradeoff between Kelly’s wages and her health insurance costs, and that she thinks her health insurance costs less than it does.

Fast forward to 2009.

  • Assume Kelly’s employer can pay 3% more to employ her in 2009 than he could in 2008. $69,000 + 3% = about $71,100.
  • Assume the premium for the family health insurance plan chosen by Kelly’s employer has increased by 6%, from $12,000 in 2008 to $12,720 in 2009.

Here is what Kelly’s employer sees in 2009:

compared to 2008
2009 $ change % change
Total amount I can afford to employ Kelly $71,100 + $2,100 +3%
minus 3/4 of Kelly’s $12,720 health insurance premium – $9,540 – $540
equals Kelly’s salary = $61,560 + $1,560 +2.6%

While Kelly’s employer paid 3% more in 2009 than in 2008 to employ her, Kelly’s salary went up by only 2.6%, because the employer’s contribution to her health insurance premium went up by 6%.

Put in $ terms, the 6% growth in health insurance premiums swallowed up $540 of Kelly’s compensation increase. She never sees or knows about that amount — it’s invisible to her.

Here is what Kelly sees in 2009:

compared to 2008
2009 $ change % change
My salary $61,560 + $1,560 +2.6%
minus 1/4 of my $12,720 health insurance premium – $3,180 – $180
equals my salary after paying for health insurance = $58,380 + $1,380 +2.4%

Kelly says, “Sure, you gave me a 2.6% salary increase (while her employer protests that it was actually 3%), but my higher health insurance premiums swallowed up some of that, so I really only got a 2.4% salary increase, plus I kept my health insurance.”

Kelly’s employer knows he is paying her $2,100 more in 2009 than he did in 2008, but Kelly thinks that she “kept her same health insurance” and got only a $1,380 wage increase. There is a $720 difference between the two views. That’s one percent of Kelly’s compensation. Rapidly growing health insurance premiums are squeezing out a portion of Kelly’s wage increases.

As Kate Baicker testified yesterday,

When the cost of benefits rises, wages fall (or rise more slowly than they would have otherwise), leaving workers bearing the cost of their benefits in the form of lower wages.

Why does this matter? It is important for policymakers to recognize that they cannot force employers to compensate employees more. They can, however, shift the form of that compensation by placing requirements on employers, either to provide health insurance (an “employer mandate”), or to make that health insurance more generous and therefore more expensive (by mandating certain benefits or premiums rules, for instance). Kate Baicker adds two important points:

When it is not possible to reduce wages, employers may respond in other ways: employment can be reduced for workers whose wages cannot be lowered, outsourcing and a reliance on temp-agencies may increase, and workers can be moved into part-time jobs where mandates do not apply. … This also means that the claimed connection between health care costs and the “international competitiveness” of U.S. industry is murky at best: higher health costs primarily lower current workers’ non-health compensation, rather than firms’ profitability.

Every time Congress tries to make health insurance more generous (and therefore expensive) through coverage or benefit mandates, they are reducing workers’ wages. They are also reducing workers’ freedom to choose the form of their compensation. It’s easy to imagine that if the Thompson family had $69,000 and a competitive well-functioning individual market in which to shop for health insurance, they might choose to spend less than $12,000 on health insurance so they would have more money for other needs.

If Congress tries to mandate that employers provide health insurance to their employees, they will be:

  • reducing the wages of those workers who now lack employer-provided health insurance, or
  • turning their jobs into temporary jobs, or
  • pushing that work overseas, or
  • just eliminating those jobs entirely.

Finally, expanding taxpayer-subsidized health insurance to the uninsured will do nothing to help the Thompson family that already has employer-provided health insurance. As long as private health insurance premiums rise faster than total compensation, their wages will grow more slowly. The proposals being considered by the Senate Finance Committee to spend more than $600 billion dollars over the next ten years (as a “down payment”) do nothing to address this problem.

And there are more than 100 million Americans in families like the Thompsons.