Customizing Health Benefits.

Employers may convert employee health-care benefits to defined-contribution plans as an alternative to traditional health plans.

At a time when managed care is increasingly under fire on Wall Street, in the media and from consumers, many companies that provide health insurance to employees are looking for workable options. One concept that experts point to as a practical solution to the traditional one-size-fits-all health plan is the defined-contribution plan.

Greg Scandlen, a spokesman for the National Center for Policy Analysis, a Texas-based think tank, said employers are taking the lessons they learned in pensions and are thinking about applying them to health care. "Companies are saying that they are tired of being the monkey in the middle," he said. "They are saying, 'We spend a lot of money on health care, and we make nobody happy? Managed care has run its course, and it's time to look at something new."

Defined-contribution health plans would work something like this: Employers give their employees a defined contribution toward their health-care premium, and the employees select the plan they want from the marketplace, based on their needs and the plan's costs. For example, employees would pay lower out-of-pocket premiums for plans with larger deductibles.

This approach could redefine a "group" as it relates to employer-sponsored health benefits. Rather than defined solely by employment, groups could be based on demographics, such as age, suited to cover a particular cross-section of people. Insurers could offer employer-sponsored health plans with features targeted to the different demographic groups.

"There's no need to have a plan that covers all features for all ages. That 25-year-old couple might want maternity coverage, while the 55-year-old couple is more interested in prescription plans," said Dr. Randolph D. Smoak Jr., a surgeon from Orangeburg, S.C., and the president-elect of the American Medical Association. "They could have more choice, and it would probably reduce the overall cost of insurance plans if they were customized better."

Smoak foresees a day when employers will give employees a voucher to buy health care. Couples could combine their vouchers to buy a family plan, and customers could keep their health-care plans when they switched jobs.

According to a Booz-Allen & Hamilton study, When Consumers Rule: The Next Revolution in U.S. Health Care, consumers will shop online for their employer-sponsored coverage at health-care superstores, which would take care of enrollment, issuing cards, provider selection and other front-end administrative services.

Building Momentum

The study predicts that employee-sponsored health plans, which cover about 62% of Americans, will evolve into defined-contribution formats over the next 10 years.

Xerox Corp. has said it was considering whether to give employees money to buy their own insurance. Honeywell International, which merged last year with AlliedSignal Inc., also is considering a defined contribution plan, Scandlen said.

A Honeywell spokesman declined comment, but the company has a history of being progressive when it comes to benefits. AlliedSignal was one of the first major companies to jump into managed care in the late 1980s, Scandlen said.

After AlliedSignal adopted managed care for its employees, several companies followed--a wave Scandlen predicted could be unleashed when one well-regarded company adopts defined benefits.

Regulatory Concerns

The idea of switching to defined-contribution plans for health benefits unleashes a host of regulatory and tax issues for employers.

A recent KPMG survey of Fortune 1000 companies found 80% of executives surveyed said they'd switch to a deferred-contribution concept if it had no impact on the company's tax situation or employees. Under current laws, the employer's contribution to health insurance coverage is tax deductible.

Scandlen said the contribution would be tax deductible as long as it didn't go directly to the consumer. The employer would put money in a trust, and the employees could direct the trust to make payments to the plan of their choice. "These are the kinds of issues that need to be resolved before large numbers of employers go that way," he said.

New Tools for New Times

Managed-care tools, such as capitation and financial incentives that are given to doctors to limit such activities as the number of tests they order, have had mixed results in controlling the supply side of health care, experts said. In the future, insurers and employers therefore will focus on controlling the demand side by passing cost and control on to consumers.

"The dilemma we face in health care is the user of health care is different from the payer of health care," said Michael Manes, a health-benefits consultant with Square One Consulting. Savvy consumers question car dealers about the price of buying a new car, but rarely think to question the price of health-care services that doctors provide, because a third party--the insurer--is footing most of the bill, Manes said.

"I think we will go to a system where individual consumers are going to have more say in their health care and its funding. And when that happens, they are going to force the system to innovate," Manes said. "When we start buying medicine the way we buy cars, we will have arrived."

Gary D. Ahlquist, senior vice president of Booz-Allen & Hamilton and coauthor of the study, said 80% of people in informal surveys said they take their cars in for regular maintenance, but only 30% said they go to a doctor for regular check-ups.

That's because consumers have no ownership of the cost of health care, he said, so they don't have a financial incentive to pursue cost-saving preventive care. As as result, managed-care companies are branded as "the bad guy" when they deny or question health-care services. That could change under a defined-contribution plan.

"Once you get into a situation where the individual is paying the health-care dollar... they will want low-cost services," said co-author David G. Knott, vice president of BoozAllen's Financial and Health Services Group. "All of the sudden, the healthcare plan becomes your friend and helps you analyze services across providers in a way an individual can't do alone." At the same time, health plans will become accountable to individual consumers, Scandlen said.

"People who are not happy with their plan will be able to vote with their feet and not be stuck with whatever their employer has chosen," he said.

Financial Incentives Come Under Fire

As aging baby boomers require more medical care and technology expenses grow, costs are rising for managed-care plans. As a result, some industry analysts say the tools of managed care, such as capitation and financial incentives, are no longer effective in controlling costs.

Capitation is the insurance company practice of paying providers a set rate per member per month. The rate does not change no matter how many times a member seeks medical treatment or the cost of treatment. Capitation can also include factors that may be beyond the physicians' control, such as hospitalization and prescription drug costs. Financial incentives are bonuses awarded to doctors for various reasons, primarily for keeping certain health care costs down.

The issue of whether capitation and financial incentives are proper--or whether they create a conflict of interest for physicians--may be decided by the U.S. Supreme Court, which is considering the case of a woman who blames her health maintenance organization for inadequate care that led to a burst appendix. In the case, Pegram vs. Herdrich, the plaintiffs argue that doctors had a conflict of interest due to the HMO's financial incentives.

"Capitation and physician financial incentives are unwinding and will continue to unwind," said Todd Richter, a Banc of America Securities analyst who studies managed-care companies. "The capitation model doesn't work in an environment like we're in."

Others hold out hope, however, that managed care can continue to successfully use those tools.

"Capitation can work very well in certain situations; it's not inherently wrong," said Greg Crawford, an analyst with Fox-Pitt, Kelton. "Physician incentives are a very important method of controlling health-care costs, and controlling health-care costs is essential to every health-care system," Crawford said.

Rising Costs

Managed care has been credited with stopping skyrocketing medical costs in the 1980s and 1990s. But the aging baby-boomer population and improvements in technology are reigniting medical inflation.

Prescription drugs have been one driver of the increases. While overall medical costs rose by 3% to 5% from 1995 to 1999, prescription drug costs rose three times as fast, averaging between 10% and 14%, according to the Health Insurance Association of America.

Insurers appear to be losing their ability to control costs when they need it most.

"We are going back to wondering how on God's Earth are we going to be able to pay for health care," rather than focusing on how to control it, Richter said. "Managed care--the way it is currently configured--is dead."

Richter said that if insurance companies couldn't continue to shift risk to providers to manage costs, they would shift it back to employers and the employees.

"Managed-care companies are being forced back to being an insurance company where they don't control costs, [they] just control their profitability by pricing and underwriting," he said.

Looking for Balance

Critics say capitation and financial incentives can limit health care to members, because doctors can make more money by refusing to give necessary treatment and tests.

Dr. Walker Ray, a pediatrician in Atlanta, refuses to accept contracts with managed-care companies that pay through capitation and financial incentives.

"I have some concerns that there's an ethical problem," Ray said. "The less care the doctor gives, the more money the doctor makes."

Dr. Don Young, chief operating officer and medical director of the Health Insurance Association of America, said any form of reimbursement has incentives built into it. Open-ended fee-for-service plans have an incentive for doctors to provide excess care, because the more care they provide, the more money they receive.

All reimbursement plans can work, but they must be balanced, Young said.

"The concern with capitation is it gives physicians incentives to control care. If they control things that are of little or no value, then that's good;' he said.

To do that, capitation must involve a large enough group of doctors and patients.

"Capitation, in and of itself, is neutral," said Dr. Maria Kuffner, president-elect of the California Medical Association. "Broad capitation, with adequate funding and a large pool of risk, can work."

If insurers tie performance to capitation, they can force innovation, said Michael Manes of Square One Consulting.

"If you are measuring quality in the outcome, you have a safeguard for rationing," Manes said.

The fact that capitation forces providers to share the insurance company's risk is not a problem, as long as providers understand the risk they are taking, Crawford said.

"The private groups that accept [capitation] must be prepared for the risks and rewards that go along with managing the costs of managed care," Crawford said.

Some groups have found the risk too great to carry.

In California, where capitation first started, one-third of all California physician groups filed for bankruptcy or closed their doors between 1996 and 1999, according to a PriceWaterhouseCoopers study.

The demise of two large practice-management groups, FPA Medical Management and MedPartners Provider Network, led to the disruption in care of 2 million patients and left doctors with $100 million in unpaid medical bills.

Young said the California situation is different because it involved third-party payers, such as FPA and MedPartners.

"The introduction of an additional party to the reimbursement scheme further reduced the pool of money that was available," Young said.

PPOs: No Gatekeeper

While HMOs may continue to use capitation and financial incentives, an alternative is gaining ground. Preferred-provider organizations, which usually pay doctors on a negotiated fee-for-service basis, are becoming more popular with consumers because they do not have a primary-care doctor who acts as a "gatekeeper."

In the past two years, enrollment in PPOs rose to 43% from 35%, while enrollment in closed-panel HMOs remained stable at 30% and open-ended HMOs, or point-of-service plans, declined to 16% from 20%, according to a study released by William M. Mercer Inc.

                              Fixed Payments
                     The average percentage of revenue
                       paid on a capitated or other
                       prepaid basis is greatest in
                           western U.S. cities.
Cities                Percent
Boston                  18%
Cleveland               19
Greenville, S.C.         8
Indianapolis            14
Lansing, Mich.          16
Little Rock, Ark.        9
Miami                   17
Newark, N.J.            14
Orange County, Calif.   31
Phoenix                 21
Seattle                 22
Syracuse, N.Y.          11
National                16%
Source: Center for Studying Health
System Change.