Why Do Firms Use Insurance to Fund Worker Health Benefits? The Role of Corporate Finance

When a firm offers health benefits to workers, it exposes the firm to the risk of making payments when workers get sick. A firm has two choices.  The firm can self-insure by paying health expenses out of its general assets and keeping the risk inside the firm.  Otherwise, a firm can insure using a firm such as Blue Cross Blue Shield, shifting the risk outside the firm. We analyze the firm's decision to manage this risk. Using data on the insurance decisions of publicly-traded firms, we find that smaller firms, firms with more investment opportunities, and firms that face a convex tax schedule are more likely to hedge the risk of health benefit payments. These financial characteristics explain more of the hedging decision relative to commonly-cited state insurance mandates. We also show that hedging health risk mitigates investment-cash flow sensitivities.