To make health insurance affordable for small business owners, the government de

Question

To make health insurance affordable for small business owners, the government decides to design a plan particularly for small companies. Since the government does not intend to make any profits, the insurance premium is actuarially faire at the national level, i.e. the expected cost equals the revenue collected from the premium if all small business owners buy insurance for their employees. For simplicity, less assume that there is no moral hazard. If the decision of buying insurance is made at the company level, will this policy sustainable without government subsidy? The government passed a legislation that requires all business owners to buy health insurance for their employees. Will this legislation improve the financial viability of this government provided insurance plan? What is the impact of the legislation on the labor market?

Explanation / Answer

Expected cost of insurance = Sum of all premiums [Given all companies invest in the plan]
But since it is not compulsory, many of the companies with low risk will not invest and companies with high risk will invest. So the expected cost will be higher than the sum of premiums in reality. So government needs to subsidize the policy.

Also there are additional costs other than the insurance payments. Like general administrative expenses, which are not included in the above equation. So government needs to subsidize the plan to account for the additional cost.

But is government makes the policy compulsory through the legislation, the above equation will hold: expected cost = sum of all premiums. This will make the policy financially more viable.

This legislation will have an immediate negative impact on the labor market, as the cost of labor for the company will go up, reducing the demand for labor and slight rise in unemployment. But in the long run, the wages will adjust (by declining) to accommodate the insurance premium in the real wage and old equilibrium will be restored.

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