Bryan Caplan  

Why Don't Big Firms Fire the Sick?

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My friend in the insurance industry once let me in on a little secret: De facto, though not de jure, virtually every big firm is also a health insurance company with an exclusive clientele: Its own labor force.  Once a firm is big enough, orthodox "health insurance companies" just charge the firm a fee equal to all its employees' health care costs plus a handling fee.  Big firms aren't buying insurance from insurance companies; they're subcontracting their paperwork.

Once you understand how the system works, there's a surprising implication: Firms have a strong financial incentive to fire chronically unhealthy workers.  Indeed, they have a strong incentive to fire perfectly healthy workers with chronically unhealthy family members.  Big firms can't shift their employees' health costs onto a third party; they are the third parties.  The marginal cost of a worker isn't his salary plus the cost of an insurance premium; the marginal cost of a worker is his salary plus his (and his family's) actual medical expenses.  Any worker who costs more than he produces is a losing venture.

Once you know these facts, populist complaints about health insurance companies make less sense than ever.  If you work for a big firm, your insurance company has little or no incentive to drop you.  But your employer does.  So why do insurance companies endure almost all of the populist abuse?  Once again, we face the case of the dog that did not bark.

The simplest answer is that employers rarely succumb to the temptation to fire the sick because they want to protect their reputations.  Firms offer health insurance packages to attract workers.  If workers expect to lose their jobs if they ever contract a serious illness, it's going to be hard to recruit workers in the first place.

The funny thing about this response, though, is that firms have much better excuses to dump the sick than straight-up health insurance companies do.  Your employer can always say, "I'm not firing you because you're sick.  I'm firing you because of the low quality of your work."  A health insurance company has far fewer credible excuses; all it can do is debate the fine print in your policy. 

Of course, if you already believe that health insurance companies jealously guard their reputations, you might conclude that even a watered-down version of this motive is sufficient to keep big firms honest.  But if you don't think reputational incentives work well in the insurance industry, if you take populist complaints seriously, you should expect big firms' behavior to be even worse.  Either way, populists' focus on health insurance companies seems misplaced.  Anyone care to defend them?


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COMMENTS (16 to date)
Cole writes:

A couple thoughts:

It could be a bureaucratic oversight. If they are contracting out the paperwork to the insurance companies then they could be unaware of the individual costs of certain employees (especially if they are healthy but have sick family members). The information would be available to them if they looked, but it might be the case where accountants at the insurance company are seeing the numbers, not at the firm.

As to why populists might get angrier at insurance companies I think you answered it yourself:

"The funny thing about this response, though, is that firms have much better excuses to dump the sick than straight-up health insurance companies do. Your employer can always say, "I'm not firing you because you're sick. I'm firing you because of the low quality of your work." A health insurance company has far fewer credible excuses; all it can do is debate the fine print in your policy."

Firms might already be getting away with it, because they can hide it, while insurance companies can't hide their reason for dumping someone from an insurance policy. Populist hate towards insurance companies might just be a much easier sell in this case.

Hyena writes:

General public dislike of insurance companies would insulate them from negative impacts on the market. Since the public expects this behavior of insurance companies, this risk is already priced into their policies.

They'd have less incentive to defend their own reputation because it would be generally impossible to do. Worse, it might be destructive because any attempt to improve the firm's reputation could increase the impact of any event which even looks like dropping people because they got sick.

RZ writes:

As a former executive, I can tell you a company is well aware of who has major health problems.
It's really inevitable, since the seriously ill person is the one who misses work the most. And in most cases, a seriously ill person will tell his supervisor about the illness, information that (rightly) gets passed along to HR.
I saw this situation several times, and we never considered firing a sick employee. There are legal reasons for not firing (see below), but I sincerely believe companies kept these employees on because management is comprised of human beings who have empathy for the ill worker. Often, the worker was an underperformer (not surprisingly), which made the problem trickier for management.
I work in insurance, and it seems to me it would be easier for a health insurer to cut someone off than for a company to do so. The insurer has a valid contract, signed by both parties, and that contract does not guarantee its own renewal.
Health insurers would go out of business were they not thick-skinned about renewals.
Companies, on the other hand, have to worry about lawsuits, especially with ADA in force. You don't want to face a jury with the plaintiff on his deathbed.
But, occasionally, people do get fired because of their illness, but the paperwork has to be in order and it can't be because of health. During her final illness, my sister was fired. The reason: excessive absenteeism.

Rachel writes:

I think you're missing the obvious. By law, employees can buy Cobra coverage from the employer for at least 18 months, and more if they're disabled. So, there's no immediate cost savings from firing the chronically sick. In theory, one could target employees with high expected costs in the far future, but that's actually pretty complicated.
The real question is: Did employees fire the sick before Cobra?

yoshi writes:

I work for a health insurance company who also insures me. One observation I've noticed is that the company is a lot more obsessive about employee health than any other company I worked for. They frequently advertise exercise within the buildings, put full nutritional information on anything and everything, have gyms at all locations, and offer "health vending" machines.

Does it work? I have no idea. You can still buy cheetos from the vending machine next to my office and fried chicken fingers from the cafeteria and the gym appears to be a favorite of those that like Days of Our Lives. It would be interesting to compare our health care costs with other companies but that information is not being released.

Trevor H writes:

In such firms, the health care costs are centralized. The managers on the ground making personnel decisions are charged a flat overhead rate per employee for health insurance regardless of individual cost. I don't see how a firm could execute such a cost savings strategy without serious harm to its reputation. Imagine, a manager picks up the phone, "Yes, hello. Who are you again? Oh, someone from corporate HR. You want me to fire Bob? Why?"

And if the firm has a performance fig leaf to hide behind such a dismissal, the low performing employee with high bills has a reciprocal strategy. "Fire me and I'll tell everyone it's because of my wife's cancer treatment bills."

Mark writes:

One thing I notice at the company I work at is very little respect for seniority. Basically, if you get older and you don't like unloading trucks while some younger employees with less seniority drives past, then check the want ads. Not completely related to your point but companies certainly can encourage turn over and keep a younger work force. High turnover and relatively young work force that doesn't even take the insurance plan offered by the company is part of that plan.

Colin K writes:

I think on this level, you can model the company as a tribe or mutual-aid society. People are much more charitable with those they know, and barring that, with those who are like them, and fellow employees will score very highly.

If HR sends an email around saying, "John Doe in finance has cancer and needs $500,000 for a lifesaving treatment," most peoples' reaction would be to reach into their pocket, rather than kick him to the curb. There but for the grace of God and all that...

Apropos Yoshi, I suspect that the main change from making this structure explicit might be to cause employees to nag their unhealthy co-workers a lot more to eat less, quit smoking, etc. At the margin, this might lead to hectoring the obese out in a few places, which in my experience already goes on for reasons of vanity rather than economy.

tom writes:

Bryan and the commenters are missing the legal risks in firing employees because of health. The federal ADA would apply, and there are lots of state laws.

Brian Clendinen writes:

It has to due with accounting policies which I think have something to due with legal issues and cost issues of collecting the information. In a large company the insurance providers gives health and cost information based on the whole population. Not areas or specific entities (maybe in some cases). I am sure the large firms could request cost break-out by person ( and pay a little more for the information) and then began charging the departments they work for this charge. That way the individual managers would go over their budgets and have incentive to get ride of these expensive workers. However because the way accountably thru measurements works in these large companies and the medical descisions are so many layers above, this does not happen.

I would need to ask a lawyer but I think their is legal issues of a managers knowing all his employees actual medical cost because along with that one would have to have information on the nature of the medical bills to know if they will be high in the future. In addition these manager would have to be held accountable by their management when they went over budget due to medical bills. I could see upper management measuring the cost but ignoring the over-runs because other departments would under-run and cancel it out. Also as someone brought up about Corba. Would the department also be charged for the net difference for their fired/laid off workers? So managers would also have to take this into consideration. I just think most managers are not financially knowledgeable enough to be able to estimate cost like this well enough to make reasonable sound cost/benefit decisions.

All of this would only work in right to work states. The restrictions in the north east and Midwest most likely add to much cost for this to be worth while. In a large corporation it is hard to get rid of people. It would be even more difficult to due it for medical reasons.


My company self-insurances and we have only about 1200 employees. Just this year my company now is charging families a higher premium for every single person over 4. So I think we will slowly see medical cost charged and be ditributed to the personal who are more costly in companies over the next decade or two.
So I think we will slowly see medical cost charged and distributed to the personal who are more costly in companies over the next decade or two.

John Goodman writes:

Two thoughts:

1. It's illegal to fire workers to avoid covering their health care costs.

2. Small firms have almost the same incentives as large ones, because they cannot buy real insurance either.

N. writes:

Just want to point out explicitly what is no doubt obvious anyway: the potential liability of hiring a worker with health problems (or from a demographic which statistically includes dependents with health problems) has a chilling effect on full-time hiring overall... and almost certainly increases by a large margin temp and contract hiring where no coverage is offered.

granite26 writes:

I think it's a simple incentive thing. The COMPANY has an incentive to fire unhealthy workers, but because of the legal ramifications, no specific employee has those incentives. HR may know the costs, but Judy from HR can't put in her anual review that she saved the compqny X dollars. So social benefit(where the society is the company) but private costs(anguish over firing Bob). We know how THAT turns out.

As supporting evidence, consider that it's big companies involved, not small ones where the owner is likely to serve as a manager of employees.

Noah Yetter writes:

There's no incentive for a manager to do this, because as you pointed out this is the health insurance arrangement at large firms. For example, I am a manager at a mid-size firm that is a subsidiary of a large multinational (Fortune 500 until recently). Why would I fire one of my employees if he/she was sickly? Never mind that it's illegal. His/her medical costs aren't paid by me, they're not even paid by my company, they're paid by the parent company way off in Newyorkistan. If this person is a good employee, it's not going to be to my benefit to dismiss them even if they're getting something hyper-expensive like a transplant or cancer treatment. Those savings just don't accrue to me, or to my boss, or even to the CEO/board of the company. A wink and a nudge would have to travel awfully far down the chain of command from where those costs are felt to where the employee in question actually works.

Robert Book writes:

Bryan, what you are describe as contracting out their paperwork is called "self-insurance." It's not really that when an employer gets big it's "as if" it's paying the health bill -- it's actually a choice variable whether to buy insurance, or pay the bills and contract out the paperwork.

Part of the confusion is that many of the companies that will do the paperwork ("claims administration") for employers are ALSO in the insurance business. (E.g. Blue Cross, etc.) So, employees get a card with an insurance company's name on it, and probably don't know whether their employer buys insurance or self-insures and buys claims administration. There are also companies that are in the claims administration business but not the insurance business; employees might not know that. It's all transparent to the employee.

Still, there are several reasons why companies might not want/need/prefer to fire employees with high (family) health care costs.

First, self-insuring employers may contract out the paperwork, but can -- and do -- buy stop-loss insurance protecting them from high costs for their entire pool in a given year, and/or high costs for a particular employee in a given year. This coverage is sold by reinsurance companies like Swiss Re, as well as companies in the "normal" health insurance business. Often the company they contract out the paperwork to will also serve as the go-between -- if not the insurer -- for this stop-loss coverage.

So, and employer might be on the hook if an employee goes from "perfectly healthy" to "torn knee ligaments needs surgery" but NOT on the hook for the entire cost of a liver transplant or something like that.

Second, HIPAA rules limit the information that the claims administrators can pass back to employers.

Third, there is some research indicating that less-healthy employees are paid less in salary; this would compensate for their higher health care costs.

(Bryan, you surely should have considered that last possibility!)

Victor writes:

Employers frequently have stop-loss reinsurance which will mitigate or eliminate the largest of problems. (assuming the reinsurer hasn't lasered the employee and assuming the claims are paid within the terms of the contract)

You're also missing a huge incentive, which is to deny the specific claims in cases where the reinsurance may not exist or is insufficient.

The Sarkisyan case is perhaps the most famous since it impacted the most recent election cycle; Cigna (the claims administrator) even came in and offered to pay the claim on behalf of the employer but yet took the PR hit. Many of Sicko's examples were similar.

I'm not saying those benefits should or should not have been paid. And very seldom if at all do we learn whether there was an existing reinsurance contract in place to protect the company.

The main takeaway is that the power of oversimplification and ideology in health insurance debates is indominatable. Inconvenient realities like self-insurance and reinsurance are swept away in the face of a stampede to proudly and confidently express one's ignorance.

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