Defined Contribution Health Care: Future Direction or Fantasy?

THERE HAVE NEVER BEEN more ideas for transforming the health care benefits system. The biggest new concept is defined contribution plans. This approach is appealing:

* Employers can limit their cost commitment, the decision process is the employees' responsibility, someone else handles the administration, and the employers' risk of litigation is reduced.

* Employees have more choices and more decision support.

* Doctors and patients have more control.

There is little controversy as to whether employer-provided health care benefits are moving toward some form of defined contribution. The only disagreement is how far and how fast. While the ultimate form of defined contribution using individual policies will not be practical within the next five years or more, employers can largely gain the desired results using currently available techniques. In addition, making changes now will position employers to embrace new alternatives as they emerge.

However, to achieve business success, employers must ensure that the direction and pace of change are aligned with their goals and philosophy. The key tradeoff for many employers is to creatively use workable techniques without upsetting employees. The optimal approach maximizes the total value--it does not merely shift the burden to employees.

One of the important issues to be considered is the role of health care benefits. If health care benefits are merely a cost of doing business, the goal is to minimize the employer's cost and time commitment. However, when well designed and administered, health care benefits are an important part of the total compensation package. In this case, the goal is to minimize total compensation costs to the employer, while maximizing total compensation value to employees.

Convenience and peace of mind are part of the "value" to employees. This tension allows the employer to produce competitive products and attract and retain quality employees. Additionally, a successful health benefits program also contributes to minimizing the employer's costs by enhancing employee productivity. But limited access to health care will likely mean more work days lost to illness and reduced productivity when at work.

Value and self-interest are both key factors in predicting changes in the marketplace and in an employer deciding on its health benefit changes. Value influences the buyer's motivation to adopt a certain approach. Self-interest influences whether the seller will offer an attractive product. An efficient market requires both motivated buyers and sellers. If either is missing, the other will be frustrated.

Value

To oversimplify the current system, there are large and small employers. The value delivered through health care benefits is much greater for large employers. Some of the elements are:

* The cost to deliver $1 of benefit to employees is about $1.10 for large employers compared with about $1.50 for small employers or individual policies. This is primarily due to the efficiency of the system--not pure negotiating power. For example, large employers can self-insure; the insurance companies' cost for sales and administration are much greater for small employers than for large groups; and insurers must recoup their costs to stay in business.

* The financial protection to employees is greater for large employers because the benefits are more attractive--the limitations are less severe and the employee co-payments are less.

* Larger employers are better able to take advantage of approaches such as disease management, case management, and employee education to reduce the cost of care and improve quality.

* Part of the value proposition is peace of mind. For health coverage offered through the employer, employees have a level of comfort that is greater than under the unstable individual policy environment.

* The tax advantages are greater for employer-sponsored health coverage than for individually purchased coverage.

The implications of this value-added system are that employers' cost of labor is minimized, while the value of compensation to the employees is maximized, by including health benefits as part of the compensation package. Moving away from the current system would either represent a cost increase to employers or a compensation reduction to employees.

If employees are to take control of their health care purchasing, employers will need to enhance their competencies. Too few employees have the knowledge and confidence to take advantage of the available information and apply it to the emotional process of arranging health care for themselves or a family member. Employers that want to change this situation have to be patient, implement a change management process, or accept employee criticism.

Another element to value is the doctor-patient relationship. It is nice to think that the doctor and patient always reach the best medical decisions. However, the evidence is not consistent with the desire. One of the reasons for the emphasis on managed care in the 1990s is that physician practices do not always reflect the medical evidence of what treatments are most effective or recognize the cost differences among alternative treatments.

For a variety of reasons, some services are underutilized (such as beta-blockers and preventive care) and others are overutilized or inefficiently utilized (such as cesarean section and certain prescription drugs). The doctor may have each patient's interest in mind, but consistent execution is difficult. in addition, the nature of medical competition is such that providers charge lower fees under a managed care arrangement than they would offer under an indemnity type plan. This is especially true for lab work and other institutional services.

While some employees will take charge of their health care, it is not likely that most will. The majority will find it too difficult to learn enough to make informed decisions, are not willing to be sufficiently assertive to manage their own care, or are not willing to devote the time. Further, the majority will not gain sufficient competencies to evaluate individual providers or negotiate on price--or even be willing to select providers largely on price. Some employers will conclude that these are the employees' problems, but most will not push them that far beyond their comfort zone.

Self-interest

One of the barriers to the ultimate form of defined contribution health care is the viability of individual health insurance. While the Internet changes a lot, it does not change the basic laws of economics. The Internet is extremely useful in efficiently matching motivated buyers and sellers. But to the extent that insurance companies have a profit motive, they will be reluctant to issue liberal health coverage at low prices to all applicants.

Insurance companies and managed care organizations will reduce their prices under a new purchasing system only to the extent that (1) they can reduce their costs and/or (2) they are motivated to reduce their profit margin. For small groups, the Internet offers the possibility of a more efficient sales and administration process (reducing commissions and other costs). But for large groups, there is less opportunity for cost savings and the profit margin is too low to be a great source of reduction.

While insurance companies and managed care organizations may be willing to subsidize a new purchasing system for a limited period, they cannot stay in business if they do so over an extended period. Employers will benefit from reduced insurance company administration costs due to new technology regardless of how they deliver their health benefits.

What would have to change

For a substantial transformation in the delivery of health care benefits, several significant changes would be required. For example, some observers think that Medical Savings Accounts (MSAs) or using high-deductible plans would improve health care purchasing by involving the buyer in the cost of care. But under employer-sponsored programs, employees have made it clear that they prefer the cost predictability of liberal coverage. Is it appropriate to force employees to shift to an approach they do not like? How many employers will take such action?

For the ultimate form of defined contribution health care to work, several tax and insurance barriers must be overcome. These include the following examples:

* The tax treatment is more attractive under employer-sponsored health insurance than individually purchased coverage. It may be possible to replicate the tax-free nature of the employer's contribution to the premium under individual coverage. But current rules preclude pre-tax contributions for the employee's share of the premium and do not allow flexible spending accounts. While it may be expected that the tax rules will be amended to give some form of tax credit or deduction for individual premium payments, it is likely that such a change would be as favorable as under employer-sponsored plans only for the lower pay levels.

* The greatest barrier to expanding access to individual coverage is adverse selection. Of those who do not have medical coverage through an employer or the government, only 27 percent purchase individual coverage. The remaining 73 percent go without insurance. One would expect that the health risk of the two groups is not the same. Insurance companies selling individual insurance are properly concerned with adverse selection--those who seek coverage are generally worse risks than those who do not. Unless this barrier is addressed, individual insurance will be more expensive and restrictive than employer-sponsored coverage. Mandatory health insurance for all and reform would be needed to address the fact that the insurance companies can make more profit by selecting good risks than by best managing health care costs. Insurance reforms without mandatory coverage may lead to insurers withdrawing from the market because they would lose money.

Making defined contribution health care work

Employers interested in defined contribution health care are generally trying to: (1) manage costs, (2) satisfy employees, and (3) minimize administrative effort. These goals can be achieved by properly structuring the employer-sponsored health benefit plans and deploying internal and external resources. The way to reach these objectives includes:

1. Better managing costs by controlling the employer contribution and making employees accountable for selecting inefficient plans. This can be achieved through the next generation of flexible benefits credits and pricing. Although the flexible benefits structure allows this control, few employers fully utilize the opportunity. In many cases, the defined contribution concept will be a long-term direction, with the pace of change influenced by employee relations considerations.

2. Enhancing employee satisfaction.

The contributing factors include the value provided, quality of service under the plans, convenience, and peace of mind. While we often focus on the financial aspects, the human aspects are often just as important. The convenience element is even more important now because employees have so little discretionary time. Similarly, service quality is critical because employees are under more pressure regarding their job performance and are more easily frustrated when their time is so precious. Employee satisfaction is enhanced by easy access to the information--but they need to know what to do with the information and want to apply it.

3. Reducing the administrative burden of managing the program.

While full outsourcing may achieve this, the financial and nonfinancial costs may be too great. Among the nonfinancial costs are the risks that the program design and operation will fit the needs of the vendor rather than those of the employer. The practical approach is "co-sourcing," where the employer retains certain roles and uses external service providers for others. The employer role may be limited to strategy and governance. Service providers may be used for advisory and operational roles.

Direction for the future

Health care will remain a challenge for employers, individuals, and legislators. As a practical matter, the current employer-sponsored approach is the most efficient system for large employers. Small employers may use purchasing cooperatives to try to gain the efficiencies large employer's experience. The advantage of the employer-sponsored approach is indicated by the fact that 91 percent of the U.S. population under age 65 with non-government health insurance have employer-sponsored coverage and only 9 percent have individual coverage.

While large employers should not abandon the advantages they have, many will seek changes to enhance results and reduce their administrative burden. Many will utilize external health benefit professionals to manage their plans. Employers should "own" their benefits strategy. The plan design, pricing of options, and selection/management of vendors should support theft business goals and philosophy. While the operational tasks can be delegated to an outside service provider, employers should have a governance role in overseeing the performance.

Employers with a well-executed operation of a tailored strategy will get the best results. While perfection may not be possible, thoughtful efforts will make a difference. Employers can enhance cost management and employee satisfaction, while reducing their administrative burden.

Rich Ostuw is the Global Practice Director for Watson Wyatt's group and bealth care practice. He has more than 20 years of experience in consulting with large companies on the design, financing, and delivery of employee benefits. He is a Fellow of the Society of Actuaries, a Member of the American Academy of Actuaries, and a Fellow of the Conference of Consulting Actuaries.

KEY CONCEPTS

* Barriers to Defined Contribution Plans

* Health Care Benefits System

* Value

* Self-interest

* Co-sourcing Benefits Plans

Will payers embrace defined contribution plans as an alternative to traditional health insurance or is this new approach a pipe dream? Are consumers truly ready to make informed decisions on purchasing their own health care? This article explores barriers to defined contribution health plans, including consumer reluctance to take ownership of buying insurance and a preference for the cost predictability of liberal coverage in employer-sponsored programs versus MSAs or higher co-payment arrangements. For the ultimate form of defined contribution health care to work, several tax and insurance barriers must be overcome. As a practical matter, the author argues that the current employer-sponsored approach is the most efficient system for large employers.