Small employers with fewer than 50 employees represent more than three- fourths of all U.S. private establishments and employ nearly one-third of the private sector workforce. (See fig. 1.) However, small employers are less likely than large employers to offer health insurance to their employees. In 1998, whereas 96 percent of employers with 50 or more employees offered health insurance, 71 percent of employers with 10 to 49 employees provided coverage and only about 36 percent of employers with fewer than 10 workers offered health benefits to their employees.The primary reason small employers cited for not offering coverage was cost. During the early 1990s, concern about small employers’ access to health insurance and the affordability of providing coverage to their employees led most states to adopt small group insurance market reforms. While the extent and scope of reforms varied across states, most states included reforms guaranteeing that small employers seeking coverage would be accepted for at least certain plans offered by insurers (known as guaranteed issue); guarantees that small employers could renew health insurance even if they had high claims except under certain circumstances, such as the failure to pay premiums (guaranteed renewal); limits on how long insurers could deny coverage for medical conditions individuals had at the time they obtained coverage (limits on preexisting condition exclusions); and limits on the variation allowed in premiums. States regulate insurance products sold within their borders, but their laws do not affect all employers. The Employee Retirement Income Security Act of 1974 (ERISA) generally preempts states from directly regulating employer-sponsored health plans. Thus, employers that assume the risk for, or “self-fund,” their employees’ health benefits are largely exempt from state regulation, including premium taxes and mandated benefits. The MEPS data from 1998 show that approximately 52 percent of large employers self-funded at least one health plan, compared with 11 percent of small employers. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) established minimum federal standards that further enhanced state efforts to ensure access to health insurance for small employers. While many of the state reforms already met or exceeded the HIPAA minimums, HIPAA ensured consistency in the definition of small employers (those with 2 to 50 employees) and established minimum standards regarding guaranteed issue, guaranteed renewal, and limits on preexisting conditions applying to both insured and self-funded health plans. States could exceed these minimum standards in their own statutes and regulations. While HIPAA helped ensure that small employers would have access to insurance, it did not impose any restrictions on premiums or otherwise address the affordability of insurance for small employers. Average annual health insurance premiums—the total amount paid by both employers and employees—were nearly the same for small and large employers in 1998. Small employers’ premiums were slightly higher than large employers’ for single coverage and slightly lower for family coverage. However, while small and large employers paid similar premiums, small employers’ coverage was generally less generous—their plans covered slightly fewer benefits and required those insured to pay higher out-of- pocket costs. Furthermore, many small employers would likely have had to pay higher than average premiums if they had provided coverage to their uninsured workers and their dependents, including those who were offered coverage but declined and those who were not offered coverage. This is because more of these uninsured individuals reported not being in excellent health than did those with insurance and most states allow insurers to charge small employers higher premiums to cover individuals in poorer health. Overall, average health insurance premiums for small and large employers varied only slightly. The total amount paid by the employer and employees for single coverage was on average slightly higher for small employers than for larger ones in 1998. Specifically, the average annual single premium was 4 percent higher ($83 more) for all small employers and 8 percent higher ($182 more) for the smallest of these—those with fewer than 10 employees. Average annual family premiums, however, were lower for small employers compared to large employers—about 3 percent lower for all small employers ($180 less) and 7 percent lower for the smallest of these ($357 less). (See table 1.) Within these average premiums, however, employers may find a considerable range of available premiums. For example, analysis of 1996 MEPS data indicates that annual single premiums at the smallest employers ranged from $995 to $4,540 per employee—about 456 percent—in 1996. In comparison, single premiums at small and large employers varied by about 369 percent and about 306 percent, respectively. While small and large employers generally paid, on average, about the same amount for health insurance coverage, small employers received less value for their premium dollars for several reasons. Small employers generally purchased coverage with higher cost-sharing requirements for their employees compared to larger employers. Also, small employers tended to receive slightly fewer covered benefits for the same premiums paid by large employers. To make coverage more affordable, small employers tend to purchase plans that require higher deductibles and higher maximum annual out-of- pocket costs for their employees. Average annual deductibles in preferred provider organizations—the plan type most often purchased by workers covered by small employers—are more than $100 higher for employers with 3 to 50 employees than for larger employers. A higher deductible typically translates into a lower premium. For example, actuarial experts estimate that a plan with an annual $200 deductible would reduce claims costs by about $65 per year compared to the same plan with a $100 deductible. Further, workers covered through small employers typically are potentially liable for higher out-of-pocket costs than those employed by larger employers. Specifically, about 35 percent of workers covered through small employers have maximum annual out-of-pocket limits that are $2,500 or more, compared to about 20 percent of workers covered through large employers. In addition, workers covered through small employers are less likely to receive certain benefits. As shown in figure 2, while workers covered through small employers were nearly as likely as those covered through large employers to have coverage for prescription drugs and adult physicals, they were slightly less likely to have coverage for other services such as prenatal care and mental health. The largest differentials between small and large employers—as much as 15 percentage points—were for benefits less likely to be covered by employers of any size, such as chiropractic care, oral contraceptives, and acupuncture. Individuals covered by small employers’ health care plans had, on average, health characteristics that were similar to those insured through large employers. Table 2 shows that selected demographic and self-reported health characteristics of individuals insured through small and large employers did not vary significantly. Specifically, whether they were insured through small or large employers, about the same percentages of individuals reported excellent physical and mental health. Moreover, nearly the same percentage of those insured through the smallest employers—those with fewer than 10 employees—reported being in excellent health (39.5 percent). Compared to individuals insured through small employers, uninsured workers at these employers and their dependents appear to be less healthy. Therefore, they could represent greater risks to insurers if small employers provided coverage to the uninsured. As shown in table 2, individuals insured through small employers had similar self-reported health characteristics when compared to those insured through large employers. However, our analysis of 1996 MEPS data shows that uninsured workers and their dependents at small employers considered themselves to be less healthy than their insured counterparts. This difference was particularly evident for workers from age 30 to 64 years and their dependents. The MEPS data showed that a smaller share of uninsured individuals in this age group reported being in excellent physical health—about 27 percent—compared to about 36 percent for insured people of similar ages. In addition, a smaller percentage of uninsured individuals reported having excellent mental health. (See table 3.) Unless prevented from doing so by state law, insurers often screen small employers for health and other risk factors associated with their workers when setting health insurance premiums and charge more for higher-risk groups. For example, we obtained premium quotes for hypothetical small employers in a selected city in each of four large states. Table 4 shows that in Austin, Texas the relatively high-risk small employer group would pay anywhere from 82 percent to 290 percent more than a relatively low-risk group. In the other three locations, premium quotes were 29 percent to 132 percent higher for the relatively high-risk small employer group. Small employers that had workers considered to be higher risk typically would have had to pay more for health insurance than healthier groups for the same coverage. Insurers’ administrative costs and expenses (other than benefits) are higher for small employers than for large employers. As a result, insurers spend a smaller share of small employers’ premium dollars on benefits and more on administrative and other expenses than they do for large employers’. For smaller employers, administrative costs such as marketing and billing are spread over fewer people. Furthermore, because large employers typically assume the risk for their employee health benefits by self-funding rather than purchasing insurance, other expenses, such as premium taxes, can be avoided. Insurers also report the potential for adverse risk selection—or purchasing of insurance by those with relatively high health care needs—is greater with the smallest groups, and to remain financially viable, insurers generally take steps to avoid covering a disproportionate share of these costly groups. Therefore, insurers may attempt to mitigate the difficulty of predicting the risk of a small group compared to a large group by reviewing the medical history of individuals in the group—called medical underwriting—or adding a premium surcharge to better ensure that they can cover costs resulting from unexpectedly large health care costs. Our analysis of existing data indicates that, overall, insurers’ administration costs and expenses, other than benefits, typically account for about 20 percent to 25 percent of small employers’ premiums compared to about 10 percent of large employers’ premiums. These expenses can range from around 5 percent to 30 percent of the premium dollar, depending on the size of the employer, type of plan, and insurer.The smaller the size of the group the larger the share of the premium that goes towards paying for expenses other than benefits.