A health plan for retirees in a time of uncertainty.

As a result of steadily increasing medical costs and the changes to accounting rules that measure the cost of retiree health plans under the Financial Accounting Standards Board statement on post-employment benefits other than pensions, many employers are taking a close look at the philosophy and financial impact of their retiree medical plans. Some have reexamined their current level of benefits; others have questioned whether they should provide a medical retiree plan at all. But employers making these decisions are likely to damage the employer/ employee relationship as well as the well-being of their employees.

What employers need, therefore, is a medical plan that provides full benefits to long-term employees at a reasonable cost and that gives them the flexibility to adjust the plan to allow for changes in the future environment.

The medical pension plan is such a plan. It incorporates into the retiree medical plan such pension plan design concepts as service-related benefits and benefits that reflect age at retirement. This modification to the typical retiree health plan enables an employer to provide a full, valuable benefit to long-term employees while eliminating the windfall benefit frequently provided to short-service employees or employees who retire early. It also provides the employer the freedom to adjust to changes in the medical care delivery system while still providing quality coverage.

By combining elements of both of these modifications to the traditional plan structure, an employer can provide quality medical coverage to long-service employees at a cost the company can afford.

Dealing with change

Employee medical plans are written to mesh with the medical care delivery system of the United States. Thus, as the delivery system evolves, medical plans evolve as well.

This constant change makes the concept of an accrued benefit difficult to apply to health plans. While it is easy to state that a retiree's medical benefit is vested at retirement, it is more difficult to define what, precisely, is vested. How can the employer reserve the right to make sensible changes that reflect changing conditions?

The answer in general is for the employer to fix the level of benefits but to reserve the right to change the means by which it provides those benefits. A plan with these features can survive radical changes in the financing and delivery of health care and can work well in today's environment as well as in the future.

How can the employer provide such a plan? are a blank check. In our current environment, the employer needs to reserve the option to select or otherwise restrict access to certain physicians while still guaranteeing a specified percentage of reimbursement.

It may be that in the future the plan will assign all its business to a nationwide HMO. Other possibilities exist, with more or less freedom of choice available to the patient. Traditional indemnity plans, which give the employee the freedom to select the physician, may well disappear.

* By promising coverage of acute care. Distinctions in types of care are blurry. The plan should avoid building false expectations about coverage of long-term care by laying the groundwork for the limitations that will be maintained over the future.

* By retaining the right to define what constitutes good care. The employer or the physicians it selects will judge medical necessity, determine proper treatment, and decide the proper modality for treatment.

* By defining the benefit in terms of some percentage of the cost of covered services the benefit percentage), leaving open bow costsharing works. This will make the three forms of retiree cost-sharing (deductibles, coinsurance, and contributions) interchangeable at the corporation's discretion.

For example, a plan that requires retirees to pay deductibles and copayments amounting to 15 percent of covered charges but no premiums may be changed to require retirees to pay 15 percent of the premium but remove deductibles and copayments.

Because it is not possible to predict the most efficient method of benefit delivery years in advance, the plan needs the freedom to change cost-sharing methods.

The medical pension design

The medical pension design preserves most of the full health benefits for longer-service retirees and reduces benefits for short-term employees and for those who retire early. Most corporations will find that this design reduces plan costs by one-fourth to one-half.

There are two elements to this design:

* The benefit level defined by the plan. The plan formula yields a well-defined level of benefits that builds during employment and is fixed at retirement.

* The way the benefit is delivered. Over time, the sponsor needs to make changes in the way health benefits are financed or delivered. The plan allows the sponsor freedom to choose between benefits of equivalent value.

This design will have the following features:

* Employees get different benefits, depending on length of service, age at retirement, and marital status.

* The benefit is defined in terms of benefit percentages (a percentage of the cost of covered services).

* The corporation is free to allocate retiree cost-sharing.

* The benefit percentages increase with increasing service, with full benefits after a specified period of service (30 years, for example).

* Benefits for early retirement are actually equivalent to a benefit at normal retirement age.

* The normal benefit (for an employee who retires at normal retirement age with the specified years of service) is a defined percentage (85 percent, for example) of covered charges before the retiree is eligible for Medicare, reduced to a lower percentage (say 65 percent) of covered charges once the retiree is eligible for Medicare.

* Spouse benefits follow this format, except that the level of company support may be reduced.

As you can see, reductions in benefits resulting from the recognition of service and retirement age can indeed reduce the cost of retiree health benefits. And use of the 85 percent/65 percent benefit percentages (as opposed to fixed deductibles, with their declining effect over time), with appropriate reductions for spouses, would reduce the cost even further.

Two caveats

This design will produce very small benefits for some employees. For example, in the case of ABC Company (see "A case study"), an employee retiring early at age 55 with 15 years of service would receive an average benefit percentage of only 11 percent, which makes coverage very costly to the employee. The corporation might wish to increase the benefit levels for these employees by reconfiguring the benefit, for example, to provide higher benefit percentages for a shorter period of time or a catastrophic type of coverage, to allow for lower employee contributions. Another alternative is to use early retirement reduction factors that are less severe than actuarial equivalence.

This design also produces high contribution rates for old retirees. (if the annual benefit percentage is held constant, the retiree's premium-sharing must eventually become very large.) To relieve the cost for the very old retirees, the corporation might well give ad hoc benefit increases to 85-year-old retirees 20 years after retirement. Or it can build in a pattern of increasing benefit percentages, so that retirees' costs increase at rates lower than full cost recognition would dictate.

Is it proper to insulate retirees from some or all cost increases? Or is it proper to share costs in the same way forever? It's easy to argue both sides of these questions, which only emphasizes the importance of addressing the questions now. There will be an advantage to looking at all retirement benefits together-pension, savings, and health-when deciding on the proper level for increases in retiree health contributions in the future.