Defined Contribution Health Plans: Moving to the Second Generation of Flexible Benefits.

After a few years of moderate increases in the mid-199Os, employers health care costs are once again moving up - up from the human resources department and back into the CFY's office. Although overall inflation in 1999 increased only 2.3 percent, employers' health insurance costs increased 5 percent across the board, and employers reporting only on managed care reported an increase of 9 percent. And the cost-driver issues have intensified, with the introduction of advanced medical treatments, heavily advertised prescription drugs, and increasingly sophisticated medical consumers. Several approaches exit for achieving health care cost containment balanced with employee satisfaction, but several converging: changes in technology and the workforce may enable a second generation of flexible benefits to best meet those twin competing goals.

With generally tight labor markets across the nation, most employers view passing through the full amount of health care cost increases to employees as counter-productive. Costs savings from the pass-throughs will be outweighed by the costs of replacing disgruntled employees. Rather, employers are weighing a number of different alternative to keep health care costs in line and to keep employees satisfied.

Some employers have suggested simply offering employees vouchers to purchase their own health care coverage. Based on employee reaction, some of those same employers have quickly back-pedaled from that suggestion. In fact, surveys by the Employee Benefits Research Institute and the Commonwealth Fund and academic studies using foous groups indicate most employees want the employer involved in health care benefits delivery. They value the employers' clout and expertise In selecting health care services and providers. This is true even when the employees' acknowledge that the employer may make selection decisions based on controlling costs.

Other employers are examining direct contracting with health are providers or the use of health marts. Direct contracting can be effective can be effective for very large employers with large concentrations of employees, but may not be practical or efficient for smaller employers with widely scattered workforces.

For most employers, a better cost saving option for health benefits is a second generation of flexible benefits packages. This 2lst century version flexible benefit plan is a true defined contribution health benefits package. It is communicated with a clear message and procedures stressing that (1) the employer is providing only a defined contribution to the package, as opposed to paying a percentage of the full cost of the package and (2)the employee will be responsible for choosing the best available package, based on the amount that employee is willing to contribute and maintain above the employer's contribution The basic second generation flexible benefits package also is coupled with a wide array of lifestyle benefits, such as day care, long-term care insurances, exercise plans, auto and mortgage insurance, and other "alternative" benefits paid for by the employee. The communications focus is not on adverse selection; but on the freedom to choose among options.

In the 1980s; the fii'st generation flexible; benefit--or cafeteria--plans became popular, in part, as a cost-savings mechanism, but also as a benefits enhancement tool. Generally the first generation flexible benefit packages produced savings largely through reductions in employment taxes generated from employees' Use of pretax: money to fund their contributions to the plan, saving both the employee arid the employer money, and through managed care. Once the initial savings from these factors were realized, benefits costs regained their upward march. Given the original flex plans failure to stabilize cost increases, both finance officers and human resources officers can be forgiven some skepticism about the cost containment effectiveness of flexible benefits.

One very basic difference between today's flexible benefits plans and the first generation flex plans is the fact the 1980s plans were usually designed and presented to employees in ways that affirmatively generated adverse selection. In fact the communications packages accompanying these plans usually focused on the theme of choose only the benefits you know your family, will use." The second generation flex plans are designed and communicated as defined contribution plans offering employees more choices coupled with more financial responsibility.

For those skeptics who believe employees will find that unpalatable, consider the considerable employee enthusiasm for 401(k) retirement plans generated over the last ten years versus the lack of employee appreciation-or even awareness - of defined benefit retirement plans. One of the great attractions of 401(k) plans for many employees is the ability to choose both the amount to save and the investments to hold those savings.

Equally important for the success of the second generation flexible benefit plans are several technical and workforce factors that have changed dramatically since the 1980s. These changes have created an environment for reengineered flexible benefits that can truly contain costs. These factors include the following.

* Pricing strategies are much more refined due to the access to information and the price controls in the market.

* Risk adjusting positively affects pricing accuracy.

* Improved technology greatly enables a much less invasive transition to flexible benefits.

Employers:

* remain the logical distribution network of health care, as the alternatives of free market and government control are not as palatable;

* need to meet demands for flexibility in health plan selection; and

* need to be able to control their financial outlay for health care benefits.

Employees:

* are empowered consumers, armed with information; and

* are demanding access and choice in health benefits.

* Employer of choice strategies allow for the addition of some more nontraditional, or lifestyle, benefits that fit well in a flexible arrangement, even though the employee is paying for those benefits.

* Self-service programs, i.e., health promotion, disease management and demand management, help crate a defined decision process for consumers.

Employers are finding that using today's technology significantly reduces administrative costs of even very complex flexible benefit plans. As a result the employer can develop more choices, priced to employees accurately enough to contain health care costs. Enrolling employees and managing those choices are also enhanced through the use of paperless technologies and communications.

Martha Priddy Patterson is the Director of Employee Benefits Policy Analysis for the Human Capital Advisory Services practice of Deloitte & Touche. She is the author of The New Working Woman's Guide to Retirement Planning, published by University of Pennsylvania Press and is a frequent speaker on issues related to employee benefits.