Small and large employers purchasing health insurance had, on average, comparable premiums in 1998, but this comparison does not fully capture the challenges facing small employers in providing health insurance for their employees. Although the premiums were similar, the health plans offered by small employers were slightly less generous on average, they had slightly higher average cost-sharing requirements for their employees and were somewhat less likely to offer some benefits, excluding, for example, mental health services and chiropractic care. Furthermore, many small employers would likely have had to pay higher-than-average premiums if they provided coverage to their uninsured workers and dependents, including those who were offered coverage but declined and those who were not offered coverage. Based on self-reported health characteristics, uninsured workers and their families at small employers were less healthy than those who were insured by comparably sized employers; and in most states, insurers could charge more to groups with less healthy individuals.

Insurer's costs to administer employer-based health insurance and protect against potentially large health care costs result in a larger share of small employer's premium dollars being spent on these nonbenefit expenses than large employers. From 20 percent to 25 percent of small employers premiums typically go toward expenses other than benefits, compared with about 10 percent for large employers. These administrative expenses include insurer's marketing and billing, which increase the per-person cost of insurance more for smaller groups than for larger ones because there are fewer people to share the cost. In addition, insurers bear other expenses that are unique to or higher for small employers, including expenses incurred to protect themselves from potentially large health care costs. For example, because they cannot predict the health status and the accompanying costs of small groups as well as they can for large groups, insurers in many states are allowed to review the medical history of each individual in the group and charge higher premiums for groups with individuals in poor health, a practice known as medical underwriting. Insurers are most likely to medically underwrite very small groups for which there is the greatest concern that the employers are purchasing coverage only because they anticipate a need for it. Insurers may also add a surcharge to a small employer's premium to lessen the impact of potentially large health care costs.

Nearly all states have enacted laws that limit the extent to which insurers can vary premiums charged to small employers on the basis of the health and other risk factors of the group. State laws that more tightly restrict variation in premiums can make coverage more affordable for small employers with high-risk employees but may also increase the cost of insurance for healthier groups. For example, in New York, a state with tight restrictions, a small employer with older workers, including some in poor health, would pay the same premium as an employer of the same size and geographic location with younger, healthier workers. In contrast, a small employer in Texas with older and less healthy workers could pay two and a half to nearly four times as much as an employer of the same size and geographic location with younger, healthier employees. Twelve states did not allow insurers to adjust premiums for the health characteristics of enrollees in 1996. Small employers in these states had average premiums about 6 percent higher, compared with the other states, when adjusted for geographic differences in cost of physician services.

Besides premium restrictions, other state efforts to make insurance more affordable for small employers have had limited results. Few small employers appear interested in lower-cost benefit packages that require significantly higher cost sharing by individuals or that scale back the benefits that are covered. Pooling small employers into purchasing cooperatives makes it easier for employees to access a broader selection of plan options, but it has not resulted in reduced premiums when compared to similar plans available outside of the cooperatives. A few states have recently established programs that provide temporary tax incentives or subsidies to encourage small employers to offer coverage to their employees. However, previous studies of the effects of tax incentives on individual and small employer behavior suggest that the incentives need to represent a significant portion half or more of the premium and to be in place permanently to result in any significant number of newly covered individuals.