Since World War II, many employers have voluntarily sponsored health insurance as a benefit to employees for purposes of recruitment and retention, and some have also offered these benefits to their retirees. The federal tax code provides incentives for employers to subsidize health benefits because their contributions can be deducted as a business expense from their taxes, and these contributions are also not considered taxable income for employees. Employer-sponsored health benefits are regulated under the Employee Retirement Income Security Act of 1974 (ERISA), which gives employers considerable flexibility to manage the cost, design, and extent of health care benefits they provide. However, ERISA established certain requirements for employers, including that they provide health plan participants and beneficiaries with a summary plan description (SPD) specifying the retirees’ rights and circumstances under which the health plan can be modified or terminated. Concern over the costs associated with retiree health benefits was compounded in 1993 when the Financial Accounting Standards (FAS) Board adopted FAS 106, requiring employers to report annually on the liability represented by the promise to provide retiree health benefits to current and future retirees. While FAS 106 did not affect an employer’s cash flow, there has been concern that listing this future liability could affect companies’ stock prices because the reporting of projected retiree health care costs affects the overall statement of financial profitability. Some companies have said that FAS 106 requirements lead to reductions in reported income and shareholder equity and are a reason for reducing retiree health benefits. As a means of reducing their reported liability as well as controlling rising costs associated with retiree health benefits, some employers have passed a share of cost increases to their retirees in the form of higher premiums, deductibles, or copayments. Some other employers have reduced benefits or simply ceased to sponsor coverage. In the absence of employer-sponsored retiree health benefits, retirees have certain coverage alternatives, but may find them to be expensive or even unaffordable. Individuals under 65 may rely on the individual insurance market or may, in limited instances, be eligible for continuation coverage from a former employer. For example, individuals whose jobs provided health benefits that ended at retirement may continue temporary coverage for up to 18 months under provisions of the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA). For eligible individuals who exhaust available COBRA coverage, the Health Insurance Portability and Accountability Act of 1996 (HIPAA) guarantees access to the individual market, regardless of health status and without coverage exclusions, but does not restrict the premiums that may be charged to older or less healthy individuals. For retirees 65 years or older, Medicare is typically the primary source of health insurance coverage. Under traditional Medicare, eligible individuals may apply for Part A, which helps pay for care in hospitals and some limited skilled nursing facility, hospice, and home health care, and may purchase Part B, which helps pay for doctors, outpatient hospital care, and other similar services. Medicare beneficiaries may rely on private retiree health coverage from a former employer or union or individually purchased Medicare supplemental insurance (known as Medigap) to cover some or all of the costs not covered by Medicare, such as copayments, coinsurance, deductibles, and most outpatient prescription drug costs.Depending on where they live, individuals may have the option of obtaining Medicare coverage on a fee-for-service basis or from a managed care or other private plan offered through the Medicare+Choice program since 1998. Many beneficiaries have been attracted to these plans because they typically have lower out-of-pocket costs than fee-for-service plans and offer services not covered by traditional Medicare, such as routine physical exams and prescription drugs. Nearly 6 million people, or approximately 15 percent of Medicare’s 39 million beneficiaries, were enrolled in a Medicare+Choice plan as of January 1, 2001, with recent plan withdrawals causing some beneficiaries to return to the traditional Medicare program. Despite a strong economy and relatively small premium increases during the latter part of the 1990s, available evidence from employer benefit surveys and employer benefit consultants we interviewed suggests the decline in employer-sponsored retiree health insurance has not reversed since 1997—the last year for which we had reported previously. Two widely cited employer benefit surveys estimate that just over one-third of large employers, and a smaller portion of small employers, offered health coverage to some of their retirees in 2000; however, one of these surveys shows the proportion of large employers offering coverage is the same as in 1997, whereas the other indicates a further small decline in coverage since 1997. Other data indicate that the percentage of retirees with employer-sponsored health insurance remained relatively stable during this time period. Still, many employers continuing to offer coverage have reduced the terms of coverage by tightening eligibility requirements, increasing the share of premiums retirees pay for health benefits, or increasing copayments and deductibles—thus, contributing to a gradual erosion of benefits. Employer sponsorship of retiree health benefits in 2000 was, at best, the same as in 1997 or, worse, continued to gradually erode according to two surveys. Surveys conducted by William M. Mercer, Incorporated, indicate that the portion of firms sponsoring health insurance for early retirees fell slightly from 41 percent in 1997 to 36 percent in 2000. Similarly, employer sponsorship of health benefits for Medicare-eligible retirees fell from 35 to 29 percent during this period. As shown in figure 1, this continues a gradual decline that began in the early 1990s. A second survey—conducted by the Kaiser Family Foundation and Health Research and Educational Trust (Kaiser/HRET)—estimates that about 37 percent of large employers sponsored retiree health benefits in 2000—the same percentage as in 1997, although with some year-to-year fluctuation. Like the Mercer survey, the Kaiser/HRET survey reflects a significant decline in coverage since 1991. Year-to-year fluctuations or gradual changes in these surveys’ results need to be interpreted with caution. These surveys are widely used and based on random samples designed to be representative of a broader employer population, but neither may have the precision needed to distinguish small changes in coverage from year to year because of the response rates and the number of firms surveyed. For example, only about 45 percent of the 1,887 firms in the Kaiser/HRET sample responded to the survey in 2000. Similarly, about 50 percent of the sampled firms responded to the Mercer survey, which included 2,797 respondents. Thus, year-to-year differences may have resulted from differences in those employers that chose to respond to the surveys. Also, while neither Mercer nor Kaiser/HRET reported the size of these sampling errors, Kaiser/HRET’s 1999 and 2000 reports indicated that 1-year differences in the percentage of large employers offering retiree health coverage since 1998 were not statistically significant. Large firms are more likely to sponsor health insurance for retirees than are smaller firms. For example, Kaiser/HRET reported that just over one- half of firms with 5,000 or more employees sponsored retiree health insurance in 2000, compared to only about 9 percent of firms with fewer than 200 employees. According to the Mercer data, the percentage of firms with 500 to 999 employees that sponsored retiree health insurance in 2000 was about 40 points lower than for those with 20,000 or more employees— about 30 percent or less compared to about 70 percent. The percentage of retirees obtaining health benefits through a former employer has remained relatively stable since 1997. According to our analysis of the Census Bureau’s Current Population Survey (CPS), in 1999, about 37 percent of retirees aged 55 to 64 had employer-sponsored coverage in their own names from former employers, as did about 26 percent of elderly retirees in 1999 (see figure 2). Since 1994, these figures varied by only 1 or 2 percentage points for early retirees and even less for elderly retirees. Year-to-year differences are too small to be statistically significant. This stability in coverage may exist in part because employers tend to reduce coverage for future rather than current retirees. Employers have adopted several strategies to limit their liability for retiree health costs other than terminating benefits, and these mechanisms contribute to an erosion in health benefits available to retirees. Some employers have restricted eligibility for retiree health insurance to certain employees, such as those hired before a certain date, thus reducing their future liability for these benefits without causing a large disruption in health coverage for those who are currently or soon-to-be retiring. According to Mercer’s data, about 5 percent of large employers sponsored retiree health insurance in 2000 for only selected employees, typically excluding employees hired more recently. Employers have also attempted to better manage or control their health care expenditures by increasing the share of health care costs for which the retiree is responsible. This approach encompasses a range of activities and includes employer efforts to increase the retirees’ deductibles, copayments, and premium share; cap the employer’s overall expenditures; or pay a fixed amount per retiree for health care. For example, more than 10 percent of employers reported having recently increased retirees’ potential out-of-pocket costs for deductibles, coinsurance, and copayments. Kaiser/HRET and Mercer, respectively, report that 16 to 25 percent of employers increased the retiree’s share of their premium contribution during the last 2 years. According to Mercer data, about 40 percent of large firms that offer early retiree health benefits now require these retirees to pay the entire premium—an increase of 8 or more percentage points since 1997. Likewise, the percentage of firms requiring Medicare-eligible retirees to pay the entire premium has increased 7 or more points during this time period. In other cases, employers have established caps on their overall expenditures for future retiree health benefits. The 1999 Kaiser/HRET survey estimated that about 35 percent of all large firms had recently capped their total projected contribution for retiree health benefits.