A New Breed of Buyers.

Defined-contribution health benefits will send employees shopping for coverage.

Over the next decade, we believe that the healthcare industry will be transformed into a consumer-focused marketplace. One critical enabler of this dramatic change will be a shift of employer-sponsored health plans away from defined benefits and toward defined-contribution formats. Much as the defined-contribution model has placed individuals center stage in determining how to finance their own retirements, employees will soon be placed in the driver's seat for selecting their own health plans and providers in an open market. (See "Freedom of Choicer page 127.)

The problems of the current defined-benefit paradigm are well known. Since employers essentially choose health plans for their employees (or offer them a very restricted range of options), consumers are not free to select benefits that meet their needs. Because employers pay the bulk of the costs associated with defined benefits, consumers are shielded from the true costs of health care and are not held accountable for the lifestyle choices that inevitably impact their health status and consumption of health services. Moreover, the current employer model is highly intermediated and costly to support. We

estimate that $18 billion is spent annually on distributing and administering employer-sponsored health benefits.

Consumer backlash against managed care, the growing ubiquity of the Internet, employer concerns over increased legal liability and a return to double-digit health-care cost increases all point toward the emergence of defined-contribution health benefits. Employers who participated in Booz-Allen & Hamilton's recent survey of Fortune magazine's "100 best companies to work for" expressed a nearly universal readiness to embrace this new approach to health-care benefits--and expect to begin doing so within the next three to five years. Other surveys have found similar results.

But employers are leery of making this move anytime soon, as long as the economy is booming, unemployment is hovering at 4% and the war for talent rages on unabated. Barring a recession or some similar jolt to the economic environment--which could galvanize a rapid, wholesale shift away from defined benefits--many employers expect to see defined-contribution health benefits emerge through focused pilot programs, offered as a new alternative in a particular division or geographic region to supplement the limited choices offered. Under this more evolutionary scenario, employees might lead the charge.

How might this brave new world work? While the industry is far from any widespread agreement on how a defined-contribution health benefit might be structured, we believe that a number of features will be critical to success. Defined-contribution health benefits must be: annual allowances; comprised of pre-tax dollars; indexed to the prevailing market prices for "base plans"; risk-adjusted for each employee; and eligible for rollover into future years if individuals do not consume all of their defined contribution in a given year. Armed with these defined-contribution dollars from their employers, we expect that employees will access an online retailer of health benefits-a future entity we call "HMOs'R'Us.com"--and select from among competing plans based on the features, risks and pricing that best meet their individual needs. These online stores will handle enrollment, card issuance, provider selection and other front-end services.

A number of obstacles must be overcome before this new paradigm can be realized, including tax law changes, underwriting innovations, improvements in the availability of information to enable informed decision-making, consumer protection legislation, employee education and continued progress in getting employees online. Moreover, there are important questions regarding the level of complexity consumers will be able to handle in selecting their health plans, providers and treatment options--not to mention the critical issue of who will be around to assist employees when problems emerge and troubleshooting assistance is required. However, a number of new competitors are already working aggressively to overcome these challenges, as are a number of today's established market leaders.

While the outcome of this impending battle remains to be seen, one thing seems clear: the economic rewards will be enormous for those who can create winning companies that meet the needs of tomorrow's primary healthcare customer--the consumer.

Larry Altman, a Best's Review columnist, is a vice president in the New York office of Booz-Allen & Hamilton. David Knott is a vice president with Booz-Allen & Hamilton's health and insurance group.