The Effect of Employer Health Insurance Offering on the Growth and Survival of Small Business Prior to the Affordable Care Act

Abstract

Whether or not small businesses offer health insurance to their employees is a critical factor in the health care coverage of many Americans, yet many entrepreneurs and decision makers fear that the cost of offering health care coverage to their employees will diminish the growth and survival of small firms. While there is an emerging consensus among economists that small businesses both create and destroy a disproportionately large number of jobs, less is known about the relationship between health care costs and business growth. We examine this latter issue prior to the passage of the Affordable Care Act in 2010.

We first review information on the relationship between small employers’ decisions to offer health insurance prior to 2010 and i) financial factors (including premium variability and tax advantages), ii) labor markets with a focus on employee characteristics and the demand for employer's health insurance, iii) insurance markets and products, discussing access and insurance options with lower premium costs, and iv) the health insurance regulatory environment with an examination of state-level reform and health insurance mandates. We then discuss employer reactions to rising health care costs, followed by a review of factors other than rising health care costs that often affect the growth and survival of a small business.

In the remaining sections, we describe our longitudinal analysis of how health insurance offering (HIO) affected the expansion and survival of small businesses. Using 2001-05 linked data from the Longitudinal Business Database (LBD) and the Insurance Component of the Medical Expenditure Panel Survey (MEPS-IC), we look at how HIO affected four measures of business performance (growth in employment, growth in payroll, growth in average wage, and survival) – after controlling for business characteristics and relevant state-level variables. We employ instrumental variable two-stage least squares estimation to address the endogeneity that permeates the question at hand.

We find that young businesses (both large and small) that offer health insurance grow at not significantly different rates as those that do not, possibly due to selection effects. Older businesses offering health insurance – both small and large – seem to have higher employment and payroll growth. Survival is strongly and positively correlated with HIO for older establishments at both large and small firms. However, these results should be interpreted with extreme caution due the concerns we raise about the available testing methodology for our context.