Defined contribution health plans: cutting edge? (An Advertising Supplement: Staffing & Employee Benefits).

Because employers pay a large portion of health expenses, employees have been insulated from perceiving the actual cost of medical care. Over the past 30 years, this arrangement contributed to an environment in which health care costs repeatedly overheated. Health care, which accounted for 7 percent of the nation's total output in 1970, has grown to represent over 13 percent. And now it's deja vu all over again as employers are seeing the largest medical cost increases in a decade.

In an effort to cool down increases in health spending, numerous cost containment strategies have been implemented. Programs such as Managed Care have had a temporary cost controlling effect, but none has resulted in sustained medical cost stabilization.

The latest initiative to come on the scene is Defined Contribution Healthcare. DC Health answers the employee's call for choice and unrestricted access while introducing a major paradigm shift: putting employees in control of how dollars are spent on the health care services they receive. Under a DC Health Plan, employees are provided a health account instead of a straight benefit, putting them in charge of purchasing decisions. The driving assumption behind this concept is that consumers shop more diligently with dollars they perceive as being their own rather than someone else's.

It is important to keep in mind that the current DC Health model is still avant-garde, having evolved from a voucher model that was being touted just a year ago. Pure DC Health Plans, where the employee is handed cash or a voucher and is then set free to shop openly for health care services, are not viable for a variety of reasons. For starters, vouchers are not tax deductible to either the employer or the employee. Furthermore, the employment-based group insurance infrastructure does not favor individual purchasers. Healthcare is distributed on a group basis to 161 million Americans below age 65 and converting to an individual market orientation would take years. Moreover, the health system is often too complicated for the average person to navigate. Forcing individuals to steer the course completely on their own would result in ill-informed decisions, dissatisfaction, and inevitable employee backlash.

When the DC Health concept was initially presented the points of criticism outlined above prevented most employers from responding favorably. In response, health plan architects went back to the drawing board and came back with a revised concept called Consumer Driven Health Care (CDHC). The CDHC model is still a Defined Contribution arrangement, but it stops short of shifting full responsibility to employees. It relies on three principles: providing employees with a spending account instead of a benefit; educating consumers to become prudent buyers of health care; and having the Plan Sponsor maintain practical and legal oversight of the plan.

CDHC Plans, modeled after Medical Spending Accounts, establish a health spending account, protected by catastrophic insurance. Employees purchase qualified health services with dollars from their spending account and are allowed to roll over unspent amounts into future years. Typically the plans are designed with a gap between the amount credited by the employer and the point at which catastrophic coverage kicks in. Once this uncovered expense, of say $5,000, is passed in a calendar year, the medical plan picks up all remaining expenses capping an employee's annual out-of-pocket costs. Complementing these plan components, additional features are being incorporated such as networks of contracted providers with specially negotiated rates, and first dollar preventive medicine benefits.

The success or failure of the CDHC model will hinge on employee response, which will be strongly influenced by how employers communicate the new plans. How employees handle their new responsibility, and their ultimate satisfaction, with the program will depend on having access to user-friendly information and clear instructions. CDHC vendors are working to provide consumers with a wealth of information available 24/7 via the Internet and toll free nurse lines. Their plans will allow employees to instantly access the status of their spending account, to compare physicians and hospitals based on cost and quality, and to educate themselves regarding treatment options and outcomes.

CDHC has the promise of developing a nation of informed healthcare consumers, but in reality, those tools are barely ready at this time. Yet the explosive growth of technology and health related information sources gives us reason to believe the market can pull this together if the demand for CDHC catches fire.

Will changing economic incentives and making information more available hook people into this new approach to health insurance? On a macro level, getting people to take charge of their health expenditures offers the greatest opportunity for high impact savings. It is hard to argue with the theory that adding consumerism to the health equation is critical. Managed Care has controlled the price and the number of services doctors and hospitals are allowed to provide. But it fails to couple that with the economic discipline budget-conscious buyers impose upon most other markets. CDHC should complement cost management efforts that have thus far focused mainly on the supply side.

There is no telling just how entrenched CDHC Plans will become. In the last decade we have tested many ideas. Some of our efforts have staying power, particularly Managed Care which 15 years ago had as many naysayers as CDHC does today. But, keep in mind the cost containment potential of Managed Care is pretty much tapped out and employers desperately need fresh solutions.

CDHC currently has a select group of enthusiastic followers and the concept has great potential. While it is still largely untested and will require a leap of faith, some large employers such as Textron and Medtronic have already signed on. Most employers who decide to try CDHC will do so incrementally, offering it to employees as an option alongside other more traditional medical plans. Searching for ways to ride out the latest wave of health care costs, it is important for employers to consider new ideas, and Consumer Driven Health Care just may provide the relief they are looking for.

Lee Exton is a Vice President and the health practice leader in The Segal Company's Los Angeles office. The Sega/Company is a leading employee benefits, compensation and human resources consulting firm headquartered in New York with offices in the U.S. and Canada and affiliates in other countries.