Most nonelderly Americans receive their health insurance coverage through their workplace. Almost all large firms offer a health insurance plan, and even though they face greater barriers to providing coverage, so do the majority of very small firms. These employment-based plans cover two-thirds of nonelderly Americans and pay most of working families’ expenses for health care and about one-quarter of national health spending. Despite employers’ role in the health insurance market, however, very little attention has been paid to employers’ motivations for providing health insurance to workers. Why do employers offer health insurance to workers? Is it because workers want it? Because their unions demand it? Or do employers offer health benefits to workers because their productivity and profitability depend on it?

The standard economic theory of the availability of employer-provided health insurance focuses on worker demand (Cutler 1997; Pauly 1997; Summers 1989). According to that theory, employers are willing to arrange health insurance plans for workers because workers are willing to “buy” that health insurance through wages reduced by the amount of the cost of the insurance. The theory states that rather than receiving additional cash compensation and finding and purchasing health insurance on their own, workers prefer to obtain coverage through their employers and so accept a wage offset to cover the cost of that coverage. This theory has a number of problems, though, not the least of which is that the data provide very little support for it. Despite decades of effort to demonstrate its validity, the empirical basis for the theory of compensating differentials remains surprisingly weak. Many empirical studies suggest that workers covered by employment-based health insurance plans earn more, not less, than do workers without health benefits (Buchmueller and Lettau 1997; Levy and Feldman 2001; Monheit et al. 1985; Simon 2001). But rather than reassess the theory, economists have focused on why the empirical research fails to produce the expected result.

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This article makes a case for reassessing the theory. A key flaw in the standard theory is that it ignores the benefits accruing to employers from offering health benefits. According to the conventional view, employees pay the full cost of coverage presumably because they believe that the benefits of health coverage are entirely for themselves. The alternative view that I am investigating posits a “business case” for employment-based health coverage, acknowledging that employers may want to offer coverage because offering a compensation package composed of both wages and health insurance is more profitable than providing wages alone.

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Employers might benefit from providing health insurance, for example, if it allowed them to recruit and retain high-quality workers. Perhaps employees who demand health benefits have other qualities that employers value; they might be forward-looking or less mobile (e.g., workers with children). Thus by offering health insurance, the firm could attract employees who anticipate establishing a long-term employment relationship. Firms might also provide health insurance if health insurance improves workers’ health, by increasing their productivity at work and reducing absenteeism and turnover. Moreover, workers in “good jobs” are happier and more productive. Rather than having only some workers insured or having wide variation in the extent and quality of coverage—as would likely happen if workers were left on their own to purchase insurance—employers could benefit from having all or most of their employees covered under plans with standard minimum benefits.

This “business case” merits a passing mention in some discussions of the availability of employment-based health benefits (see Currie and Madrian 1999, 3368; Wolaver, McBride, and Wolfe 1997), but it is not central to the standard theory, and economists have typically minimized its importance. In a discussion of the impact of a government mandate, for example, economist Mark Pauly ruled out any real benefits to the employer. Employer-provided health benefits, he argued, “will have little effect on the employer’s bottom-line. Workers may be a little bit healthier and a little happier … and that will presumably benefit employers a little. But the main consequences, positive or negative, of increasing workers’ insurance coverage will fall on the workers themselves” (Pauly 1997, 84). In a recent paper in which he reviewed existing empirical evidence, economist Thomas Buchmueller also found that employers reap few or no “spillover benefits” from providing health insurance to workers. Academic studies, he concluded, show little evidence that health insurance improves workers’ health and productivity, reduces turnover, or substantially cuts employers’ costs associated with workers’ compensation and absenteeism (Buchmueller 2000).

Despite the short shrift afforded the business case in mainstream economics, it seems worthwhile to reassess it. Although Buchmueller’s review may seem to settle the matter, he neglected to discuss a number of recent studies analyzing the productivity effects of poor health. But perhaps a more compelling reason for a reassessment is that many employers seem to think health and health coverage affect workers’ productivity and organizational performance. A burgeoning “health and productivity management” literature argues that the value of health coverage far exceeds its direct cost to employers. Even if employers have only recently begun to appreciate the value of health coverage for employee and firm performance, as some experts suggest (e.g., Ceniceros 2000), it would be helpful to document and understand that shift in perceptions.

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Changes in the business community’s perceptions of the value of secondary education in the early 20th century offer a useful comparison. As economic historian Claudia Goldin explained, at the turn of the century, education at the secondary and higher level was viewed as providing “‘private,’” not public, goods: “unlike the elementary schools, which taught basic skills thought to be essential to a democracy and needed to coordinate commercial activity, high schools were often depicted as producing skills accruing entirely to the individual” (Goldin 2001, 19-20; italics added). By the early 20th century, though, people and training, not capital and technology, had become the new concerns. Capital embodied in people—human capital—mattered. The result of this shift in perceptions, according to Goldin, was that for the first time “the post-literacy schooling of the masses was perceived to greatly economic production” (Goldin 2001, 1). The growing sense in the American business community that secondary education mattered to them helped spur investments in education.

Like education, health is a key component of human capital (Becker 1964; Fuchs 1966; Grossman 1972). Education and skills, after all, are embedded in people, whose productivity depends on their health. It thus seems reasonable to suspect that at the turn of the 21st century, employers may have concluded that health insurance coverage and other investments in their employees’ health are important to productivity and organizational performance—and more now than in the past because of advances in medical care and its rising cost.

Indeed, employers are said to be concerned with the return on investments in employer-provided on-the-job training, for which U.S. employers budgeted an estimated $58.6 billion in 1997 (Bartel 2000, 502). It thus seems incongruous that employers would see no potential for returns on investments in health, on which more than $335 billion was spent in 2000 (Cowan et al. 2002).

Furthermore, even if empirical progress has been slow to date, it bears keeping in mind that economists have frequently struggled to demonstrate the empirical importance of certain propositions because the principal concern is notoriously difficult to measure. In a revealing comment in a lengthy survey article on health, health insurance, and the labor market, economists Janet Currie and Brigitte Madrian observed that “academic research has only recently substantiated that health is a consequential determinant of labor market outcomes. Economic agents, however, have long recognized the importance of this relationship” (Currie and Madrian 1999, 3363). Their comment is noteworthy because it acknowledges that it took economists a very long time to quantify a phenomenon that seems intuitive to noneconomists (i.e., that health affects individual economic performance). The question I am raising is whether economists should make a greater effort to assess the relationship between health coverage and firms’ outcomes.

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