The Hawaii Medical Service Association will raise rates by 2.6 percent for roughly 9,500 small businesses on July 1, the Insurance Division said Wednesday.

The state’s largest health insurer originally proposed a 3.9 percent premium increase for small businesses but lowered the rate request to 2.6 percent after the state questioned HMSA’s projected medical costs.

The increase will apply to more than 110,000 workers at businesses with fewer than 200 employees and was approved this week by the state Insurance Division, which regulates health plan rates.

The Insurance Division estimates that reducing the rate increase to 2.6 percent from 3.9 percent will save small businesses at least $6.6 million this year.

Even the lower rate increase has small businesses worried.

"It’s going to impact us in a negative way because we have so much costs … to begin with. It’s coming out of our bottom line," said Mike Tory, owner of Tory’s Roofing & Waterproofing Inc., which offers HMSA plans to its 45 employees. "Most times we can’t pass that on to our customers because it’s so competitive. It’s already tough to make a profit the way it is right now. If companies need to survive in this economy, we need to have less costs, less taxes, less regulations."

Susan Mulkern, vice president of Mulkern Landscaping, which employs eight full-time workers, said the company dropped HMSA when premiums grew too costly.

"No longer are employers able to offer good benefits for their employees," she said. "A lot of people are simply employing people part time to avoid giving out these benefits. Most of these plans are in excess of $400 a month per employee."

Hawaii Insurance Commissioner Gordon Ito said the state has been able to hold the line on rate increases because "medical cost trends are starting to moderate."

"In the last two years, the rate increases have dropped to an average of 3.15 percent," Ito said. "Between 2007 and 2010, the average rate increase for preferred provider plans was 9.35 percent. The last two years has seen a drop of nearly two-thirds that rate."

HMSA said it is working to reduce medical costs to keep rates low.

"We continue to implement programs that we believe will slow the growth in health care costs, such as our new agreement with Hawaii Pacific Health, the performance-driven contracts with Hawaii’s hospitals, and our patient- centered medical home initiative," said HMSA spokeswoman Elisa Yadao.

"This is the lowest approved rate increase in at least 10 years," Yadao said. The increase also is below Honolulu’s 3 percent inflation rate.

Melissa Pavlicek, Hawaii state director for the National Federation of Independent Business, which has 1,100 local members, said health insurance continues to be among top cost burdens for small businesses.

"Even if the increases don’t appear to be keeping up with inflation, we’re still trying to deal with our revenues by and large still being down due to the bad economy," she said. "Health insurance is a huge cost so any increase is very difficult to bear. Small-business owners are trying to survive. This is not the time that we can afford paying more in health insurance costs."

HMSA’s original rate request was calculated based on actual health care costs, projections and inflation, as well as administrative expenses, HMSA said. But HMSA and the Insurance Division differed on what future costs would be.

"Although HMSA does not agree with the Division’s assessment, we believe that reasonable people can disagree and have revised our medical plan rates to conform with the Division’s medical cost assumptions," Yadao said.

Tim Lyons, president of the 900-member Hawaii Business League, said, "The original increase request seems questionable when a reduced rate is voluntarily agreed to."

HMSA recorded a $12.8 million profit in the three months ended March 31, its highest first-quarter gain since 2004. Reserves at the end of the quarter were $422.1 million.