State Mandates on Private Insurance

Gail A. Jensen

Gail A. Jensen is an associate professor of economics and gerontology at Wayne State University.

One of the fastest growing areas of regulation in the health care sector is state-mandated benefits for private insurance plans. These are state laws that prescribe the content of health insurance purchased from Blue Cross/Blue Shield and commercial insurers. Mandated benefits often apply to the coverage of particular providers, such as chiropractors and psychologists, the coverage of services, such as alcohol and drug abuse treatment, and the coverage of types of individuals, such as children with disabilities and terminated workers.

This article briefly describes the scope of those regulations, considers why they exist, summarizes what we know about their effects in insurance markets, and finally, raises some policy questions regarding the regulations.

Mandated benefits are important because they have recently evolved into a major category of insurance regulation and because they can have some undesirable effects on the provision of health insurance. In 1991 there were approximately 850 mandates across the states. That total is up from close to none in 1970, and roughly double the number in 1980. The rate of enactment of new mandates has dropped off somewhat since 1988, but many states are now modifying mandates already on the books. If those modifications are in fact additions to existing requirements, and I suspect that they are, then the trend to impose even more mandates is still running strong.

Mandates may increase a firm's costs of offering group health insurance and consequently its costs of hiring labor. When insurance costs increase, employers may act in ways that attempt to avoid those higher costs. For example, a firm may choose to reduce workers' insurance benefits in nonmandated areas, require that workers pay a larger share of the premium, or reduce workers' wages or other fringe benefits. Worse still, a firm may decide that group coverage simply is not worth the cost, if mandated benefits are sufficiently burdensome, in which case it declines to offer insurance at all. Large firms also have the option of self-insuring their plans to avoid mandates. The 1974 Employee Retirement and Income Security Act, otherwise known as ERISA, gives self-insured plans an exemption from all state regulations pertaining to insurance. Thus, by self-insuring a firm is able to deflect all costs associated with state insurance regulations. A self-insured firm need not offer state-mandated benefits, and it can avoid paying premium taxes on its plan. An important policy issue in the area of mandates has to do with ERISA's preemption of state laws. I shall return to that topic shortly.


Why Have the States Passed Those Laws?

There are two schools of thought on this question, not completely exclusive of each other. One explanation is that states have intervened to correct certain shortcomings in the market for group insurance. It is conceivable, for example, that insurance purchasers have unknowingly undervalued the benefits of some types of care. In this case a mandate may, if chosen appropriately, raise a population's demand for coverage to a level more in line with what it would have been had buyers been well-informed at the beginning. Another possibility is that there is "adverse selection" in the market for special coverages. Here again, a mandate may, if chosen appropriately, improve on the competitive market outcome.

An alternative explanation for mandates is that those laws simply serve the political interests of state legislators, and they do so in several ways. First, in an era of strained state budgets, mandates enable legislators to seemingly extend the protection of society's safety net without having to raise taxes. Mandates may also reduce the state's own expenditures for particular services, such as mental health care, because they provide a means to shift treatment costs to the private sector. The shift occurs because some patients who would otherwise seek treatment from public providers will instead use the private sector because their insurance now covers care in those settings. Public funds are then freed up to spend in more politically attractive ways. In addition, mandates tend to appease small but politically energized provider groups that stand to reap enormous financial benefits from an increased demand for their services after a mandate is enacted. And while there are costs associated with mandates, those costs tend to be borne mostly by politically diffuse and unorganized groups, in particular, workers in smaller firms that offer health insurance. State legislators balance the competing interests of their various constituencies in deciding whether to enact a particular mandate; they trade their votes for support at election time.

While those theories certainly appeal to reason, the empirical support for any of them is extremely weak. There is very little evidence for either the systematic undervaluing of certain benefits or adverse selection with respect to special coverages. Actual mandate enactment patterns across the fifty states also at best conform only modestly to a political interest theory. When applied to the passage of mandates for mental health care or psychologists' services, the political interest theory fits moderately; but when applied to alcohol and drug abuse mandates, it does not appear to fit at all.


The Effects of State-Mandated Benefits

Several studies have investigated the consequences of mandates for insurance markets. I shall summarize what we know on the basis of three recent studies conducted by Michael Morrisey, Jon Gabel, and me, a study by John Goodman and Gerald Musgrave, and other research by Tom McGuire, Richard Frank, and others. Overall, there appears to be a much better mesh between theory and observation when we examine the effects that state-mandated benefits have in insurance markets. There are four questions that available studies allow us to address. First, who is affected by state-mandated benefits? Second, what are the costs of mandates? Third, do those regulations discourage small firms from offering insurance altogether? Finally, do they spur firms to self-insure?

Regarding the first question, although a mandate enables some workers and their families to gain access to a special service, a large majority of a state's population will often be unaffected. Mandates have no effect on persons who lack employer coverage to begin with, who are covered by Medicare or Medicaid, or who belong to a self-insured plan. Altogether, those four categories of persons make up 72 percent of our population. Thus, in a typical state, less than 30 percent of the population tends to be covered by purchased group insurance coverage and hence subject to mandates. Not all of these persons, however, are actually affected by a mandate. Only those who would otherwise lack the benefit are affected. Workers and their families in plans offered by smaller firms are probably more affected because benefits in those plans tend to be more modest.

On the cost question, several studies indicate that mandated benefits do indeed raise the price that some employers pay for health insurance. Mandates are not money savers. Any firm that previously did not offer a coverage now mandated sees its premiums increase. And those additional costs must ultimately be paid by workers in the form of lower wages, lower levels for other fringe benefits, or lower employment.

Not all of those new costs to employers, however, are new costs to the health care system. Some of the new costs represent a shifting of costs from other payers. Persons who gain insurance for care that they currently pay for out-of-pocket see their own expenses decline, because their costs have been transferred to employers. A state government, too, may see its own health care expenditures decrease. For mandates related to mental health care, the savings to state budgets have been substantial. In fact, because of the expenditure offsets for other payers that occur when employers begin providing a benefit, looking solely at employers' additional premiums will tend to overstate the costs of a mandate. The new costs for society associated with a mandated benefit will be less than employers' new premiums because the employers' expense ignores the resulting savings to other payers.

On the small firms question--whether mandates discourage them from providing coverage altogether--research reveals that they do. Some small firms forgo offering health insurance because of state-mandated benefits. Studies estimate that about one-fifth of small firms that do not currently offer insurance would offer it in a mandate-free environment. Businesses most likely to offer health benefits if the burden of mandates were lifted tend to be more established and higher wage firms that are not currently offering coverage.

On the fourth question, research indicates that state-mandated benefits are responsible for only a small part of the tremendous growth in self-insurance that occurred during the 1980s. Studies show that a large majority of self-insured plans actually contain coverages that are mandated. And among firms that were not already self-insured, the decision to switch to self-insurance has not been found to correlate with the level and scope of mandated benefits in a firm's state.


State Continuation-of-Coverage Mandates

Of the most common mandates, a continuation-of-coverage requirement for terminated workers appears to be the most burdensome for firms. That type of mandate allows workers who would otherwise be severed from their employer's plan because of termination to remain in the plan provided they pay the group rate themselves. Essentially, those laws are state predecessors of the federal COBRA legislation (the 1985 Consolidated Omnibus Budget Reconciliation Act), which provides continuation rights for terminated workers and employees' dependents separated from an employer's plan. The state laws, however, differ from COBRA in that the eligibility periods tend to be shorter, and the state laws usually apply to all firms offering coverage, not just firms with twenty or more workers, which is the group to which COBRA applies.

State continuation-of-coverage mandates, more than any other state insurance regulation, decrease the probability that a small firm offers health insurance. For example, the presence of that mandate reduces a small firm's probability of offering coverage by about 10 percentage points. Also, before COBRA the presence of that type of mandate was the most significant determinant of a larger firm's decision to self-insure. Since COBRA took effect, however, the influence of state continuation-of-coverage mandates has been diluted. This should not be surprising because once COBRA took effect, self-insurance was no longer a vehicle for avoiding that type of benefit. Even self-insured firms must comply with COBRA.

Why are continuation-of-coverage requirements so troublesome? There is a serious adverse-selection problem with continuation enrollees. Claims data indicate that individuals who are very high risk tend to stay on in a plan while low risks drop out. That, in turn, drives up an employer's overall cost of offering coverage. The administrative costs associated with continuation enrollees are also reportedly high.

In light of those findings, some observers have suggested that we modify COBRA to alleviate the adverse-selection problem. One idea is to change the legislation so that the rules governing eligibility for COBRA coverage, and the financing of coverage, are similar to unemployment insurance. If coverage were designed like unemployment insurance, all workers would be eligible for continuation coverage after some period of time with the firm, and that coverage would be paid for by employers' contributions into a "COBRA insurance pool." Presumably, an employer's contribution could be partly experience-rated, the same way its unemployment insurance contributions are currently experienced-rated.

Such a scheme would certainly alleviate the adverse-selection problem, and it would also extend coverage to a greater number of the unemployed. But it might be extremely expensive for smaller firms. Because their employee turnover is so much higher, small firms would have to pay much higher contributions to the program. Available estimates suggest that small firms are very price sensitive in their decisions to offer coverage. Thus, it is quite likely that some would drop coverage altogether under such a scheme. Clearly, there would be a trade-off between the number of persons with current-worker coverage and the number of unemployed who gain insurance.


Efficiency and Equity in Insurance Regulation

From a health policy standpoint, mandates of all types raise some important issues of both efficiency and equity. Research has demonstrated that society pays a price for mandated coverages, a price that has several dimensions. First, mandated coverages do raise health insurance premiums. They are not, with few exceptions, cost-saving. And while the price tag for individual mandates may appear small, collectively their cost is substantial. Second, mandated coverages discourage small employers from providing health insurance. Research demonstrates that one in five small businesses that do not offer health benefits to their employees would do so in a mandate-free setting. Third, mandated coverages exacerbate the growing sense of lost control, on the part of both managers and workers, over the persistently rising cost of health benefits. The flexibility of small to midsize businesses to tailor benefits to workers' preferences and to what they can comfortably afford has eroded significantly with the growing number of mandates.

Are the expanded benefits worth this price? Recently enacted legislation in almost half the states suggests that the answer may be no! Twenty-two states have now passed what I call mandate-awareness bills, most in 1990 and 1991. Nearly all of this legislation either calls for an impact statement on proposed mandates before their enactment or lifts mandated benefits for small firms newly entering the insurance market. Although it is far too early to tell whether the various mandate-waiver programs will be successful, the research on small firms' purchasing decisions suggests that they will be.

In addition to the efficiency questions raised by state-mandated benefits, ERISA's exemption for self-insured plans raises an issue of equity between small and large group insurance plans. By interpreting ERISA as preempting state laws for self-insured but not purchased plans, the courts have effectively created a two-tier regulatory system for employer-sponsored coverage. On one tier are purchased plans under state scrutiny. Those plans pay state taxes, must comply with a large number of rules on the content of coverage, and maintain state-specified reserves to prevent their insolvency. On a different tier are self-insured plans over which the states have no oversight. Those plans pay no taxes, are exempt from all state mandated benefits, and need not follow sound actuarial practices. By avoiding the costs of regulation, self-insured firms can, in principle, attract workers with compensation packages that cost less than those offered by firms that do not self-insure. Thus, firms that do not self-insure are at a competitive disadvantage in labor markets compared with self-insured firms. Because the former firms tend to be smaller, ERISA's exemption arguably has weakened the ability of small firms to compete effectively against large firms.

Most observers agree that when ERISA was enacted, the dual regulatory treatment of insurance plans was a fully unforeseen and unintended consequence. With a majority of persons now in self-insured plans, policymakers at the federal level must consider whether to maintain the current regulatory vacuum for self-insured plans--that the courts have created--or to change federal law so that health insurance plans are again treated equally, regardless of self-insurance status. With regard to changing the law, there are two directions federal policy could take. One would be to eliminate ERISA's preemption for self-insured plans. The other would be to expand it to all employer-sponsored insurance plans. The first would leave health insurance regulation with the states, where it largely was until the self-insurance boom of just a few years ago. The second strategy would essentially turn regulation over to the federal government. In either case purchased plans and self-insured plans would again be regulated on a more appropriate "equal basis."

Each strategy, however, is very different in terms of its likely effects on employers and employees. Under the first approach, self-insured plans would be newly subject to existing state mandates. Thus, firms with plans containing less than the mandated standards would have to either expand their benefits or drop coverage. Since most mandates are cost-increasing, insurance premiums would rise. Small to midsized firms that currently self-insure would incur the largest premium increases, since those firms (more so than larger self-insured firms) tend to exclude mandated coverages from their plans.

Large, multistate firms, most of which now self-insure, would also see costs rise, since their plans would have to comply with the requirements of all the states that have jurisdiction over them. Although most of those firms already offer the more common mandated coverages, such as alcohol, drug abuse, and mental health care benefits, it is the multitude of "peripheral" or uncommon coverages, such as in vitro fertilization, social workers, and acupuncture, that would cause premiums to rise. Even if each state in which the firm operated has only one or two peripheral mandates, the combined costs could be substantial.

Firms whose premiums rise would attempt to deflect the increases. There are four actions those firms could take, none of which is appealing: reduce wages, reduce fringe benefits in nonmandated areas, reduce employment, or drop insurance altogether. The measure taken would likely depend on the size of the premium increase and worker preferences over those choices. In any event, removing ERISA's exemption clause would expand benefits and hence costs in many firms, and workers would ultimately pay for their new coverage in unwanted ways. In an era when real wages throughout the economy have actually been declining, an expansion of mandates could intensify the downward trend.

The second strategy Congress could take--expanding ERISA's preemption to all plans--would have very different consequences. Eliminating state mandates would actually lower insurance costs for most small firms since insurers would be able to offer plans that cover only the most essential services--plans more affordable than those available today. More small firms would offer insurance as a result. In one study Jon Gable and I found that in the mid-1980s state mandates across the entire country accounted for at least a fifth of noncoverage among small businesses. Thus, eliminating mandates might spur significant numbers to offer health benefits. Several other studies also suggest that small firms would respond by newly offering coverage, thereby reducing the number of employed uninsured in this country. With lower insurance costs, small firms would be able to compete more effectively with large firms in the labor market. Finally, insurance regulation would be greatly simplified for all concerned. The current fifty sets of often conflicting state coverage rules would be replaced by a single federal set enacted by Congress.

Although both approaches to ERISA would achieve equity in the regulation of group health insurance, only the second has the potential to improve efficiency in that market. Whether equity and efficiency should be the goals of public policy in health care is a question that ultimately depends on the values of our elected representatives.

Selected Readings

Gabel, J.R. and Jensen, G.A. "The Price of State-Mandated Benefits." Inquiry, Vol. 26 (1989).

Jensen, G.A. "Regulating the Content of Health Plans" in R. Helmes, ed., American Health Policy: Critical Issues for Reform. Washington, D.C.: AEI Press, 1993.

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