Health Benefits and Wages: Minimizing Total Compensation Cost.

This paper studies the role of health benefits in an employer's compensation strategy, given the overall goal of minimizing the total compensation expense (wages plus health-insurance cost) for a fixed number of workers. The employer's basic benefit package consists of a base wage and a moderate health plan. It may also offer the option of upgrading to a generous health plan for an additional surcharge. Optimally, the base wage is set in order to balance the total wage bill against the expected cost of health care. In setting the charge for generous coverage the employer acts as a monopolist who sells generous health plans to its employees. The cost-minimization approach is shown to be less vulnerable to adverse selection than other common approaches to the pricing of health benefits, but it may result in excluding some healthy workers from employment. (This paper is a revision of RWP01-023.)