Employment Cost Index

Trends in Health
Insurance Costs

BY ALBERT E. SCHWENK.

One of the distinguishing features of the Employment
Cost Index (ECI) is that it provides information on trends
in employer costs for benefits as well as wages and salaries.
Since 1979, when benefit data first became available from
the ECT, benefit costs in private industry typically have risen
faster than wages and salaries, but movements in these two
components of compensation have roughly paralleled each
other. (See chart 1.) The major exceptions to this patter
were in 1981-82, 1985-87, and 1992-96. The latter two
exceptions can generally be explained by unusually small
increases in employer costs for health insurance.

This article concentrates on one component of the in-
surance category—health insurance—which accounts for
about 90 percent of the total cost of insurance. It examines
fluctuations in the rate of increase in health insurance costs,

Albert E. Schwenk is an economist in the Division of Compensation Data
Analysis and Planning, Bureau of Labor Statistics, Telephone (202) 606-
6203.

evaluates their effect on total benefit costs, and attempts to
explain them.

Benefits covered by the ECI

The ECI covers wages and salaries and five major cat-
egories of benefits. Table 1 shows the cost per hour worked
and percent of total compensation for those components of
compensation for private industry. Legally required ben-
efits is the most important benefit category, accounting for
nearly one-third of all benefit costs; insurance and paid leave
account for about one-quarter each, and retirement and sav-
ings and supplemental pay about 10 percent each.

Trends in health insurance costs

From 1980 to 1983, health insurance costs as measured
by the ECT accelerated steadily, reaching an annual increase
of 23.5 percent in the 12 months ended March 1983. From
that point, the rate of increase declined steadily, to 3.5 per-

Percent change
16

Chart 1. Percent changes in wages and salaries, benefit costs, and total compensation, private industry workers, 1980-96

4e

we

10

4 1 1 1 1 L 1 1

1960 1961 1962 1963 1964 1985 1986 1967

1968 1969 1990 1991

1982 1983 1994 1995 1996

31 Compensation and Working Conditions December 1996



Table 1. Cost per hour worked for components of compensa-
tion, and costs as a percent of compensation, private industry
workers, March 1996

Percent of
‘compensation’

1 Due to rounding, percentages may not equal total.

cent in the 12 months ended June 1986. It again acceler-
ated to 14.7 percent in the year ended December 1988, but
then slowed, reaching a low of -0.3 percent in the year ended
in March 1996,

Fluctuations in health insurance costs are a major rea-
son for deviations between benefit cost changes and wage
and salary changes. Chart 2 shows that when health insur-
ance is excluded, benefit cost gains are closer to wage and
salary increases.

Fluctuations in the rate of increase in health insurance
costs reflect a number of factors, the most important of which
are changes in the cost of medical care and cost contain-
ment efforts by employers.

Changes in the cost of medical care are provided by the
medical care segment of the Consumer Price Index (CPI).!
Chart 3 shows that rates of change in the CPI for medical
care (lagged 1 year) roughly paralleled changes in the health
insurance index from the ECI, although the ECI measure
was much more volatile.* That is to be expected, because
the ECT reflects not only the cost of medical care but also
employer/employee choices regarding plan types, employee
contributions, and other factors.

The steady declines in the rate of increase in employer
health insurance costs during 1983-86 were due to slow-
downs in the rate of gain in the cost of medical care. Ap-
parently, more important were employer efforts at health

care cost containment. While it is not possible to quantify
the effects of each type of cost containment, a review of cost
containment efforts does shed light on what employers did
to control their health insurance costs.

To contain health insurance costs, employers have used
a variety of approaches, including shifting some or all of
the burden to employees. As a consequence, the percent-
age of employees whose health insurance premiums are
wholly paid by employers has declined sharply since 1980.
Thirty-eight percent of full-time workers in medium and
large private establishments had individual coverage wholly
financed by their employer in 1993, down from 54 percent
in 1986 and 72 percent in 1980. Twenty-two percent were
eligible to receive fully employer-paid coverage for their
families, down from 35 percent in 1986 and 51 percent in
19803

These changes in employee contributions for health in-
surance coincided with a number of changes in health plan
design expected to curb costs. For example, some health
care plans were redesigned to eliminate basic coverage for
certain types of care, and placed payment arrangements
under a major medical plan. Under a major medical plan,
the employees were required to pay a deductible (a mini-
mum initial payment for medical costs made by the in-
sured individual before plan benefits can be used). The
deductible requirement was an attempt to discourage
unnecessary use of plan benefits, thus reducing the cost
of insurance. These major medical deductibles have
increased over time to keep pace with the rising cost of
medical services.

Employers also explored ways to reduce their expenses,
such as creating self-funded plans instead of using com-
mercial health care insurance plans. Self-funded plans were
viewed as a way to save money by allowing companies to
retain funds which would otherwise be used to pay insur-
ance premiums, and to eliminate taxes on insurance premi-
ums, as well as giving the companies more control over
plan design and expenditures. In 1979, 11 percent of all
medical plan participants were covered by self-insured plans
in medium and large firms; by 1988, the proportion had
tripled to 34 percent; by 1993, nearly half of medical plan
participants (46 percent) were in self-funded plans.

Chart 2. Percent changes in wages and salaries, benefit costs, and ben private Industry workers, 1980-96

16

fae
T
~S

TTTTTTTTT

Wages and salaries"

1980 1981 1962 1983

1964 1985 1986 1967 1988 1989 1990 1991

1982 1993 1994 1995 1996

‘Compensation and Working Conditions December 1996 32



Chart 3. Percent changes in the Consumer Price Index for medical care (lagged 1 year), and Employment
Cost Index for health insurance, 1960-96

1. A 1 1 1 1

1960 1961 1982 1983 1984 1965 1966 1987 1968 1989 1900 1901 1982 1903 1904 1995 1996

In addition to self-funding, there was a greater reliance
on managed care programs, such as health maintenance
organizations (HMO’s) and preferred provider organiza-
tions (PPO’s). HMO’s are prepaid health care plans that
deliver comprehensive medical services to members for a
fixed periodic fee. According to the Bureau’s Employee
Benefits Survey (EBS), 5 percent of employees in medium
and large firms were covered by HMO’s in 1984, 13 per-
cent in 1986, and 23 percent in 1993,

PPO's provide coverage for individuals on a fee-for-ser-
vice basis and offer a choice of providers. According to the
EBS, 1 percent of employees in private medium and large
firms were covered by PPO’s in 1986 (the first year the data
were tabulated); by 1993, 26 percent were.

Some cost savings were realized through changes in plan
design that increased the employer’s control over the type
of health care services employees were able to use. Ex-
amples of these changes include requiring second opinions
for surgical procedures and prehospitalization testing, as
well as creating incentives to use outpatient facilities, to
buy generic prescription drugs, and to audit hospital bills.*

Calculating benefit cost changes

The Employment Cost Indexes for benefits, like those
for wages and salaries, are fixed-weight Laspeyres mea-
sures of the change in the cost of employing a fixed set of
labor inputs. The fixed weights—currently industry and
occupational employment counts for 1990 that come largely
from the Bureau’s Occupational Employment Survey—en-
sure that changes measured are unaffected by employment

shifts among industries and occupations with different wage
and benefit cost levels.

It is important to emphasize that benefit cost indexes
are not price indexes for a fixed market basket of benefits.
Rather, they measure the change in an employer's cost for
providing a benefit package. For the ECI, the cost for ben-
efits may change in four primary ways:

¢ The cost for an unchanged benefit plan may increase
or decrease (for example, an insurance carrier raises
its rates, or the proportion of the insurance cost paid
for by the employee rises);

* A benefit plan may be added or eliminated (for exam-
ple, a dental plan is added);

* The provisions of a benefit plan may be modified (for
example, the type of work covered by the dental plan
is enhanced); or

* Usage of the benefit may change because of changes
in the plan (for example, more employees elect health
insurance because of improved dental benefits).

In general, changes in health insurance costs are not
likely to be directly related to changes in wages and sala-
Ties, because, for workers covered by a plan, the cost of a
plan is going to be the same regardless of the level of earn-
ings.> This is in contrast to other types of employee benefit
plans, such as paid holidays and vacations, that are tied
directly to wages.

—Endnotes—

‘The CPI for medical care prices a fixed market basket of medical com-
modities and services.

? The change in ECT health insurance costs showed a closer relationship
1 the CPI for medical care lagged 1 year than to the concurrent change in the
CPI for medical care. For example, the March 1993-March 1994 change in
ECT health insurance costs were more closely related to the March 1992
March 1993 change in the CPI for medical care than to the March 1993-
March 1994 change.

> See, for example, Ann C. Foster, “Employee Contributions for Medical
Care Coverage,” Compensation and Working Conditions, September 1996,
pp. 51-53.

‘For more information on employer containment of health insurance costs,

33 Compensation and Working Conditions December 1996

see Stephanie Hyland, “Health Benefits Show Cost Containment Strategies,”
Monthly Labor Review, February 1992, pp. 42-43; Thomas P. Burke, “Al-
temnatives to Hospital Care Under Employee Benefit Plans,” Monthly Labor
Review, December 1991, pp. 9-15; and Robert B. Grant, “Outpatient Sur-
gery: Helping to Contain Health Care Costs,” Monthly Labor Review, No-
vember 1992, pp. 33-36. These articles are all reprinted in Employee Ben-
efits Survey: A BLS Reader, Bulletin 2459, Bureau of Labor Statistics, Feb-
muary 1995.

3 Of course, the likelihood of a plan being offered by an employer is di-
rectly related to an employee's earnings. See, for example, Albert E. Schwenk
and William R. Bailey, “Employer Expenditures for Private Retirement and
Insurance Plans,” Monthly Labor Review, July 1972, pp. 15-19.