Employment-based Health Insurance and Misallocation: Implications for the Macroeconomy

Most working-age Americans obtain health insurance coverage through the workplace. U.S. law requires employers that offer health plans to use a price common to all in the group, but the value of insurance to each risk-averse individual varies with their idiosyncratic health risk. Hence, linking employment and health insurance creates a wedge between the marginal cost and benefit of insurance. Since health risk can be sizable and health insurance is part of total employee compensation, the wedge can affect firm and employee decisions. We study the impact of this wedge on occupational choice, productivity and welfare in a general equilibrium model with agents who are endowed with idiosyncratic health risk and heterogeneous managerial ability. Agents choose whether to be a worker or entrepreneur. We find that the wedge distorts occupational choice by causing two types of misallocations. Some highly skilled individuals with adverse health shocks leave entrepreneurship while individuals with intermediate skills but favorable health shocks opt to manage firms. Four counterfactual policies are analyzed: expansion of employer-based health insurance; private insurance only; health insurance exchanges; and universal health coverage. Welfare effects may be positive or negative, vary significantly with an individual’s position in the asset and ability distributions, and are sensitive to changes in risk aversion. We also assess the effects of the policies on firm size, productivity, GDP and earnings. JEL Classification: E23, I10, O40.