Abstract: Implementation of the Massachusetts health care reform has largely failed to address the needs of small businesses and their employees. Given that small busi­nesses generate most new jobs, this breakdown also consti­tutes poor economic policy. As other states take up health care reform under the implementation deadlines of Presi­dent Barack Obama’s health care law, they would be wise to implement health reforms that best address the needs of their states, including their small business communities. States should eliminate counterproductive health care mandates and craft reforms that promote market choice and competition, which will help to control the cost of pro­viding coverage for the employer and help to provide affordable, quality coverage for employees.

In implementing the Massachusetts health care reform, officials have let down the small business community. While the plight of the small business community was a central concern of former Governor Mitt Romney (R), the state’s administrators, executive branch, and legislature have paid little attention to the pressing problems of small businesses. Worse, current Massachusetts officials have exacerbated the situation in how they have implemented the reform.

Small businesses in Massachusetts, especially those with 10 or fewer employees, remain close to the national average of employer-offered coverage of 67 percent, compared to 98 percent for the rest of Massa­chusetts businesses.[1] The Massachusetts Employer Survey shows the gravity of the situation for small companies with 50 or fewer employees. For exam­ple, the median monthly premium for a family health plan for small firms (50 or fewer employees) has risen 46 percent since 2001.[2] After adjusting for variations in geography, demographics, and bene­fits, small employers pay higher premiums on aver­age than mid-sized and large-sized companies, and their premiums are rising more quickly.

The strain on small businesses has been docu­mented in recent published accounts of small firms beginning to drop coverage.[3] While Common­wealth Care,[4] the state’s subsidized program, has seen annual premium rate hikes of around 5 per­cent, rates for small businesses have increased 15 percent per year over the past five years, according to a survey commissioned by the Retailers Associa­tion of Massachusetts.[5] State-collected data from 2007 and 2008 also show a small decrease in pre­mium contributions by small employers as costs continued to rise. [6] This trend could help to explain declining employee participation in employer-offered insurance at small companies.[7]

Given that 90 percent of the roughly 185,000 businesses in Massachusetts are small companies, which historically create two-thirds of all new jobs in Massachusetts, state officials’ failure to consider the needs of small businesses is bad economic pol­icy, especially during a downturn.[8]

An estimated 97.5 percent of Massachusetts res­idents are now covered by health insurance. For low-income persons, particularly those who previ­ously had no health insurance, the 2006 law has been a positive experience. Yet the state’s decision to offer virtually free insurance to these residents has come at the expense of helping small businesses, which could employ these same individuals if they had received rate relief in their health insurance. These implementation decisions have cost the state millions in additional subsidies that could have been averted if some of these individuals were cov­ered under an employer-sponsored plan. Other states should closely examine Massachusetts’s deci­sions during implementation to avoid making the same mistakes when designing and implementing their own reforms.

How Implementation Undercut Original Intent

Implementation of the Massachusetts health care reform has largely failed to address the needs of small businesses and their employees.

Small Business–Friendly Elements of the Romney Reform Design. Governor Romney’s orig­inal health reform proposal envisioned a statewide health insurance exchange that would have offered small businesses a robust choice of plans with a wide range of deductible and benefit levels.[9] His proposal provided for defined contributions from employers, used the exchange as a “premium aggre­gator,” and created a pooling mechanism to allow employees of small businesses to purchase group insurance together to spread risk and provide greater premium stability. It was a market-oriented, consumer-centered agenda designed to promote personal choice and ownership of portable health insurance for employees in small businesses.

The design was informed by survey data show­ing that roughly 78 percent of the uninsured in the state were employed, a majority working full-time, but their employers were struggling to afford health insurance coverage.[10] The goal was to provide affordable plans to all residents by:

• Empowering consumers to pick their own insur­ance plans with innovative benefit designs that met their insurance needs;
• Promoting greater competition and price trans­parency; and
• When necessary, leveraging monies already being allocated for uncompensated care at hospitals to assist the poor in purchasing insurance instead.

The original proposal called for benefits that focused on value: preventive and primary care, emergency services, surgical benefits, hospitalization benefits, ambulatory patient care, and mental health benefits.[11] This value-driven standard is significant when juxtaposed with the minimum creditable cov­erage (MCC) that the Connector Board approved for 2011.[12] The MCC includes 17 coverage require­ments and 28 benefit mandates for all health carriers that sell insurance.[13] These mandates have contrib­uted to driving up the cost of coverage.

Romney’s proposal for an exchange provided incentives for small business participation, such as different rating standards for small businesses and a discount for low tobacco usage and participation in wellness programs.[14] The plan helped to level the playing field for small business employees by enabling them to purchase insurance with pre-tax dollars. Allowing small businesses to participate in the exchange would streamline the administrative burden and limit the minimum participation and contribution hurdles that had previously prevented many businesses from offering coverage.

The proposed policy was a thoughtful alternative to the heavily regulated and restrictive nature of the health care insurance market at the time.[15] It would have helped to elevate the individual employee as the primary decision maker and injected competi­tion into the system to apply downward pressure on increasing costs. Even with the policy compromises required to pass the health care reform bill in 2006, the final version still included mechanisms that would have helped small business in the short term—if they had been implemented.

Altered During Implementation. During imple­mentation, these mechanisms were altered in ways that changed the design and the outcome for small businesses.

Outcome. The 2006 health care reform law tasked the Connector[16] with developing a small business program. The originally planned launch date was July 1, 2007, but coverage was not final­ized until January 2009, almost three full years after the health care reform bill was signed. Even with this lengthy delay, the Contributory Plan (CP), the original program, suffered from design and incen­tive issues.[17] Instead of engaging with the broker community that sells mainly to small businesses, the Connector allowed only 20 brokers to sell CP and then only to the companies that were already their clients. Because of budget restraints, the Con­nector offered these brokers a 2.5 percent fee, com­pared to the 4 percent standard commission that they could earn outside of the Connector.[18]

The designs of the health insurance products offered through the Connector lacked creativity, were very similar to options available outside of the Connector, and sometimes were more expensive.[19] While plans were required to be rated using a mod­ified community rating similar to plans outside of the Connector, CP insurers were prohibited from re-rating a plan regardless of the characteristics of the final enrollees. Additionally, for employees choosing to deviate from the employer-selected benchmark plan, a list billing (or age rating) was used, making the switch unattractive to older workers.[20] The plans lacked network diversity as most plans allowed full access to all providers regardless of cost. At the time the legislature prohibited the Con­nector from offering mandate-lite plans to small businesses, prohibited pooling purchasing groups, and limited the program to employers with 50 or fewer employees. Finally, the Connector narrowly focused advertisements to employers not already offering insurance.

Not surprisingly, the program drew limited inter­est from the small business community and failed to reach its initial goal of 100 employers. As a result, the Connector launched a new small business pro­gram called Business Express (BE),[21] “put[ting] its resources into one effort for small businesses,” and froze enrollment for CP.[22]

However, Business Express also suffers from design limitations and does little to address the underlying reasons behind premium increases. It does reduce the monthly fee that small employers typically pay to third-party administrators from $35 per subscriber to $10 per subscriber, saving employers roughly $300 per employee per year.[23] However, this reduced fee is not unique to the Con­nector. The Massachusetts Business Association contends that it offers a similarly low-priced plan. While BE has drawn more interest than CP, BE enrollment has been boosted largely by a deal with the Small Business Service Bureau to transfer its cur­rent membership to BE.[24]

Politics. The current policies reflect current political attitudes. The Connector Board, the gov­erning body of Massachusetts’s health insurance exchange, is composed of a voting majority of gov­ernment officials and union representatives.[25] Its actions have reflected the interests of its member­ship, not the interests of the Massachusetts small business community.[26] The sum effect of the board’s policy decisions is to provide expansive, high-cost, defined-benefit health insurance plans designed by state bureaucrats. The Connector and its governing board erred on the side of being pro­scriptive, instead of allowing flexibility and permit­ting market forces to operate.[27] The board’s efforts have focused on offering heavily subsidized insur­ance plans for low-income individuals and raising the floor of what it deems the acceptable minimum level of coverage. By contrast, states interested in helping their small business employees gain access to affordable health insurance should pursue mar­ket-based policies that encourage health insurance as a means of protecting individuals and families from the financial disaster of a serious and costly illness. The composition of the governing board is an important factor in reaching this goal.

Reduced Choice. Overregulation and an inten­tional limiting of health plans have left small businesses with few choices. In the most recent example, the Connector reduced the number of plan options in the Business Express program from 25 to seven.[28]

Early on, multiple board members expressed a desire to reduce the number of choices and to fur­ther standardize the plans offered in the Connec­tor. The decision to reduce choice for employers seems to have originated not only from board members, but also from a handful of small focus groups conducted in 2007 and 2009, in which consumers expressed a desire for a simple pro­cess.[29] However, the focus groups’ desire for plans with meaningful differences in benefits and prices was ignored.[30] The wishes and needs of small businesses were not surveyed and infrequently discussed. Leaders of the small business commu­nity have expressed a desire to have more information and diversity on the exchange.[31] However, the Connector failed to establish a system that offered competitive insurance products that were afford­able to small businesses.

Finally, the executive branch’s rejection of hun­dreds of actuarially sound premium increases prompted four major carriers to boycott the BE pro­gram, thereby reducing choices available for small businesses. These carriers represent 90 percent of the private insurance market, and their boycott reduced the Connector to sending letters to them requesting their return.[32]

Government Benefit Setting. The Connector Board sets minimum creditable coverage (MCC) for insurance, sets the state’s sliding scale subsidy lev­els, and defines affordability standards for the state’s individual mandate to purchase health insur­ance. The Connector’s approval process requires plans to clear a much higher bar for covered bene­fits than what had historically been present in the state’s general insurance market.[33] On the staff’s recommendation, the Connector Board continued to raise the required minimum level of coverage, which was already very high.[34] For example, in 2007, the board voted to make Massachusetts the only state in the nation that mandated prescription drug coverage, requiring more than 250,000 resi­dents to “upgrade” their coverage and pay more for insurance in perpetuity.[35]

In addition, board members have expressed a desire to classify more mandates as core services, to cap deductible levels, and to bar monetary limits on coverage.[36] The legislature has shown a willingness to support these efforts. The FY 2011 Senate budget included provisions to exempt early intervention services from co-payments and deductibles.[37] The concern for the small business community was not about the provision of early intervention services, but about the precedent set by starting to waive co-payments and deductibles that result in cost increases.[38] By removing the cost-sharing mecha­nism, such as co-payments and deductibles, employ­ers are less likely to be able to control health care costs and maintain lower monthly premiums through innovative benefit design. Consumers are more likely to consume additional health care ser­vices further driving up costs.

Increasing MCC levels reduces the affordability of plans in the market. In the future, even if the Connector Board changes the definition of afford­ability without meaningfully reforming the MCC, they may spare some citizens a fine, but they will leave many without coverage, and everyone else will still pay more for their coverage. With a high MCC, the barriers to entry for new health plans also become increasingly complicated. Other states should note that flexibility in benefit design allows robust choice and competition, which help to keep plans reasonably priced.

Costly Mandates. State-mandated benefits dis­proportionately burden small businesses. Larger companies that span multiple states or countries and self-insuring companies are regulated under federal law and are therefore exempt from state mandates.[39] In 2005, Massachusetts health care mandates accounted for $1.32 billion (12 percent) of premium prices. That number has certainly risen as the Con­nector and the legislature have added numerous mandated benefits over the past five years. A report that examined plans exempt from state health care mandates estimated that “the marginal direct cost” of mandates in 2005 added at least 19 percent to the increase in premium costs of plans subject to state mandates.[40] Massachusetts business leaders have similarly argued that current mandates cost 15 cents of every new health care dollar spent.[41]

The Massachusetts legislature has responded by expanding the list of mandates to include prosthetic devices, hypodermic needles, mental health cover­age,[42] and coverage of autism services.[43] The autism law, the most recent expansion, is expected to drive up annual spending per insured person by $14.64 to $29.40, adding $340 million in addi­tional premium costs.[44]

Unfair Penalties Against Some Small Busi­nesses. An additional source of cost pressure is the “fair share” contribution assessment on employers (the employer mandate). Putting aside the fact that employer-mandate penalties are passed onto employees in the form of lower compensation, the current assessment standards are adversely affecting many small and mid-sized businesses.

In 2006, the standard required of employers with 11 or more full-time equivalents (FTEs) to make a “fair and reasonable contribution” toward their employers’ insurance—either 25 percent employee participation in an employer-provided group health plan or the employer paying 33 percent toward the cost of individual plans for full-time workers. The administration of Governor Deval Patrick proposed changing this to require all employers to meet both the participation and contribution standards. Under pressure, the policy was partially reversed to exempt employers with fewer than 50 FTEs.[45]

Yet anecdotal evidence indicates that businesses with 50 to 100 FTEs have been caught up in the reg­ulatory mandate. These companies are being assessed a fine that is not in line with the spirit of the statutory law. One flaw in the regulation is that enforcement does not consider coverage that employees may have from other sources. For exam­ple, an employee could have insurance through a spouse, Medicare, or the U.S. Department of Veter­ans Affairs. Furthermore, some companies could have numerous part-time or seasonal employees who are ineligible for the company insurance.[46] Consequently, the regulation gives companies an incentive to pry into potential and current employ­ees’ personal lives if the employer is close to the par­ticipation threshold, and this could lead to discriminatory hiring and firing.

Perhaps more troubling is that the “fair share” mandate gives companies an incentive to reduce their employees’ working hours to qualify them for state-subsidized care. According to a recent Fortune article, home health care organizations and other companies have already shown a willingness to do just this.[47] The regulatory change places another burden on businesses with 50 to 100 employees, which drives up costs and drives down wages.

With an individual mandate in place, moving to a defined-contribution system would be a more transparent alternative than the fair-share contribu­tion. A defined-contribution system would allow employers to assist their employees in purchasing insurance on the exchange, instead of penalizing employers (and employees) for not meeting arbi­trary participation and contribution thresholds.

Shortsighted and Inadequate Solutions. States pursuing health care reform should be particularly wary of short-term solutions to control health care costs for small businesses. Increasing health care costs is not a problem that will be solved in the short term. It must be managed. Sadly, most of the proposed solutions in Massachusetts have been shortsighted at the expense of finding viable long-term solutions.

The Patrick administration’s approach of capping premium rates and rejecting hundreds of premium increases, as seen earlier this year, is neither viable nor useful. Insurance companies may be easy polit­ical targets, but artificially capping rates without actuarial consideration is ultimately an ineffective method of cost control. It threatens the long-term viability of insurers and their ability to reimburse providers. Furthermore, if the state moved instead to set reimbursement rates for providers, experience has shown that many providers would simply respond by performing more procedures and tests.[48] Both methods fail to address the underlying causes of increasing health care costs.

Governor Patrick recently signed into law a bill intended to provide relief for small businesses.[49] While the bill is a step in the right direction, it does not go far enough. Its most promising measures are provisions for up to six small-business group pur­chasing cooperatives to cover 85,000 lives, the addition of an insurance broker to the Connector Board, and a review of mandated benefits every four years.[50] However, there is serious concern that the cap on the number of lives to be covered (85,000) will be inadequate for the roughly 167,000 small businesses and their family members that would qualify. Further, having a big pool is not sufficient to realize meaningful savings. Pooling must be paired with market-based reforms that result in groups that mirror larger firms by being stable and random in its membership. Without these features, pooling will not realize success.

The law also contains a few worrisome elements. The executive branch is granted the authority to reject premium rate increases if they are deemed “excessive…or unreasonable.”[51] Furthermore, an automatic rejection is executed if carriers do not spend 90 percent of premium dollars on care or their administrative costs increase more than the rate of medical inflation in New England.[52] These arbitrary standards for rejection of actuarially sound premium increases do nothing to address the underlying cost of care and could increase health care spending as insurers try to meet the thresholds. These policy mechanisms are flawed short-term solutions in a state with many non-profit insurers with contractual agreements to honor, and the oper­ating losses that they accept, could undermine long-term sustainability. RAND analysts have argued that savings from artificially limiting growth of premium rates will likely be very small and reduce the quality and availability of insurance products.[53] A tempo­rary reduction of products did take place when insurers boycotted the Connector’s small business program earlier this year.

Other provisions require insurers that sell to small businesses to offer at least one tiered network or limited-coverage network plan with a premium 12 percent below other full-network plans. Addi­tionally, the law offers limited participation for a select few small businesses in wellness programs. The law codifies Governor Romney’s desire for greater transparency of insurers and providers to educate consumers about carrier costs by specific group size, provider costs, and quality of care. Finally, one provision reduces the five-year age bands, which insurers use for risk rating and pric­ing, to one-year age bands to protect small busi­nesses from large premium increases when employees move up to the next age band. However, while this policy prevents one-time spikes, it simply spreads out the cost of insurance and fails to address underlying cost issues.

Happily, the compromise bill passed by the leg­islature left out many of the misguided ideas included in earlier versions of the bill, such as a 5 percent state tax credit for small businesses mod­eled after the federal credit. The National Federa­tion of Independent Business estimates that only 42 percent of Massachusetts small businesses would qualify for the federal credit. Nationally, CBO esti­mates that only 12 percent of businesses are expected to take advantage of it in 2016.[54] The leg­islature also wisely omitted an ambiguous cost-shifting “shared-sacrifice contribution” that would have imposed a $100 million assessment on provid­ers and hospitals to “help” small businesses.[55]

Overall, the law will only marginally assist small businesses in the long run. True long-term savings cannot take hold from price controls. Massachusetts missed many opportunities that other states should use in their own reforms.

Building a Small Business–Friendly Exchange

Under the recently enacted Patient Protection and Affordable Care Act, Congress requires states to establish their own health insurance exchanges by 2014 or to accept a federally designed exchange. However, states should not wait until 2014 to reform their health insurance markets, and they should consider establishing their own health insurance exchanges.

In Massachusetts, the original vision for health care reform included provisions that would have directly assisted small businesses if they had been implemented wisely. To best address the needs of small businesses, states should:

• Promote defined contributions through the exchange. Moving toward a defined-contribu­tion system in which consumers are given a fixed amount of money to purchase their own health care in an exchange would lower costs for both employers and employees. Instead of each employer being forced to offer the same insur­ance plans in the same tier to all of its employees whether they are 65 years old or 35 years old, individuals could choose the level of coverage that best met their individual needs and prefer­ences. This type of system allows employees to take ownership of their health care spending and become shrewd consumers. The ease of adminis­tering this system permits more companies to use the exchange, expanding coverage and facil­itating greater competition.
• Set up a premium aggregator that allows con­tributions from multiple sources. Coupled with a defined-contribution system, a premium aggregator can provide three robust benefits. First, it can reduce the administrative burden and costs of the normal premium payment pro­cess. Second, it can leverage all of the pre-tax contributions available to employees, such as contributions from multiple part-time employers or a spouse’s employer. Finally, it can spread the cost of insurance across multiple employers, minimizing employees’ out-of-pocket costs.
• Implement risk-adjustment mechanisms. A risk-adjustment system for carriers can reduce barriers to market entry and empower insurance companies to innovate with benefit designs. Risk-adjustment mechanisms can protect indi­vidual carriers from being saddled with higher costs resulting from adverse selection (i.e., a carrier that insures a more costly group of indi­viduals in a given year). Risk-adjustment mecha­nisms also can dampen premium volatility for small employer groups.[56]
• Allow greater choice of health plans with more information on price and quality. Massa­chusetts did its small business community a dis­service by limiting the diversity and number of plans.[57] Greater choice helps to tailor insurance to the employees’ needs and to restrain costs by limiting overutilization. A far better policy would be to provide the broadest range of information in a user-friendly format to companies and con­sumers.[58] Making prices transparent will help both consumers and providers. Stakeholders should agree on a common standard for calculat­ing the prices of services for providing that infor­mation to consumers. Greater price transparency is likely to lead to enhanced efficiency in the health sector.
• Reduce the number of mandates. Small-sized employers should be allowed to choose high-deductible and mandate-lite plans. Given the desire for greater cost containment, legislators should revisit the mandated benefits and repeal those that impose unnecessary costs. For exam­ple, a better standard for MCC might be found in the federal Health Insurance Portability and Accountability Act of 1996.[59] Other states, such as Indiana, Utah, and Georgia, have acknowl­edged this concern by passing their own ver­sions of low-premium, high-deductible plans or mandate-lite plans over the past five years. State legislatures, including the Massachusetts legisla­ture, should allow for more flexibility for small business plans. One possibility is to make the broker fee a rating factor for small business plans instead of including it in the insurance rate.
• Allow market forces to control the underlying health care costs. Given the fragmented nature of the health care sector, policymakers need to realign incentives at the ground level to change the behavior of individual consumers and practi­tioners to control costs and improve quality. While time-consuming compared to bureaucrat­ically derived decrees, using market forces to control costs will be more effective in maximiz­ing value in the health system over the long run.

A consumer-centered health care market would compel insurers to fundamentally alter their practices to offer better value than their compet­itors. Carriers would only remain viable if they offer better value coverage that is attractive to consumers. This would also encourage provid­ers to introduce new products that integrate new benefits, such as “multi-year contracting, pre­mium discounts for participation in wellness or disease management programs, and cash rebates to subscribers who successfully meet agreed-upon health improvement goals.”[60] These and other innovative product designs would align incentives for all stakeholders to partner together to realize methods to keep patients healthier for less.

A consumer-centered exchange shifts an em­ployer’s role from acting as the middleman in purchasing insurance for their employees to providing “financial engineering and decision-support services.” It would change the govern­ment’s role from mandating one-size-fits-all designs to providing financial assistance.[61] Gov­ernment officials must acknowledge that not all consumers require the exact same coverage and that carriers must be allowed to innovate to serve different population subsets better. Finally, government officials need to abstain from price setting in any form because it unavoidably dis­torts the marketplace, harming both carriers and consumers. Consumers are key to making the health care system more rational and efficient.

Conclusion

States looking to create state health insurance exchanges that are friendly to small business should design exchanges that allow defined contributions for health insurance, which will promote market choice and competition. They should include a mechanism that allows people to aggregate health care contributions from different employers, both for employees with more than one job and for cou­ples with different employers. Finally, state legisla­tures should reduce or eliminate health benefit mandates that drive up costs, and they should sta­bilize their health insurance markets by establishing risk-adjustment mechanisms to compensate for adverse selection.

Massachusetts’s original design for health care reform held promise for small businesses, but policy decisions made during implementation have failed to deliver on that promise so far. Greater availability of state-subsidized coverage and rising premiums reduce employers’ motivation to provide coverage for their employees, and the incentives in the new federal health care legislation will certainly intensify that problem.

The long-term sustainability of any reform plan will rest largely on the level of engagement with small businesses and cost relief delivered to them. It is imperative that each state move forward quickly in an informed manner to address the needs of the small businesses and their millions of employees. The future economic strength of the nation may be at stake given the depth of the current recession and the pressures placed on small businesses and their employees as they try to stay in business.

—Joshua D. Archambault is a Graduate Fellow in the Center for Health Policy Studies at The Heritage Foundation and a recent graduate of the John F. Kennedy School of Government at Harvard University.