How to tame health care costs: there's no end in sight to annual premium hikes.

It's no exaggeration to call the continuing double-digit rise in health insurance premiums a crisis. In recent years employers of all sizes have faced premium increases of 12% to 15%. Some hikes have even gone as high as 30%. In 2002 the average national increase was 12.7%, up from 4.8% in 1999. And there's no end in sight. Here are some steps CPAs can advise clients and employers to take to minimize these increases.

WHAT MAKES THEM RISE?

While CPAs can trace premium escalation to many factors, two predominate. First, baby boomers are hitting their 50s. It goes without saying that an aging population consumes more medical resources. Second, and independent of demographics, is a steep rise in prescription drug usage, including both quality-of-life drugs, such as Vioxx for arthritis pain, and new vaccines and medical breakthroughs, such as Merck's vaccine to prevent HPV, the cervical-cancer-causing virus. This double whammy is driving employers to look for virtually any means they can find of abating health care costs.

Short of dropping employee health coverage altogether, an unlikely option, the most likely source of relief for overburdened employers is to minimize cost increases, rather than try to eliminate them entirely. It's clear that neither the government and health care providers nor insurance companies will pick up the additional premium costs. So it falls to two groups--employers and employees--to pay for them.

At a time of tight budgets, employers can't rely on the federal government for additional health care funding or for a national health plan. Providers, both hospitals and doctors, have taken hits with reduced Medicare funding and escalating costs of their own, including malpractice insurance premiums. Insurers, living with declining interest rates, are in no position to dip into their reserves to pay for increased health care costs. Indeed it is the insurance industry's drive to pass on its costs that is the immediate cause of the crisis. The only way employers can meet the strain of higher premiums is to shift costs to employees.

There are two strategies CPAs can recommend to employers to accomplish this shift. The first is to drop coverage entirely in peripheral areas such as dental and vision plans. Traditionally, these coverages have large employee co-pays (on a percentage basis) and are capped at low maximum annual benefits. In general, employees tend to regard such plans as less necessary than medical coverage, which makes cutting them less likely to cause employee animosity. Still, this is the least beneficial cost-shifting strategy. Terminating dental and vision coverage will provide companies with only a one-time savings. Most important, these plans are not the real culprits when it comes to increasing costs. Dental and vision costs actually have remained relatively stable in recent years.

In media reports insurance companies blame rising drug costs for nearly one-third of premium increases. The most effective way CPAs can suggest employers minimize the impact of these increases is to raise co-pays, either with a "premium co-pay" whereby employees share the premium cost (and increases), or a "policy co-pay," meaning employees pay a set amount to the medical provider for treatment or prescription drugs. Companies can use either strategy separately or together. The savings each generates is a function of employee demographics and policy terms. Given that each employer's situation is unique, this article will describe the basic differences between the two strategies. CPAs then can help employers personalize them to their own circumstances.

PREMIUM CO-PAY

CPAs will find the premium co-pay has the most direct effect on an employee's paycheck. Assume a 20% cost sharing for family coverage with a monthly premium of $500. The employee pays $100 and sees that reflected immediately in her or his paycheck. While the premium-co-pay method brings the employer the most direct dollar benefit by reducing its share of premium outlays, this approach also is likely to create the highest level of employee antagonism. To help address this issue, employers sometimes use a tiered approach, having lower-paid employees pay a smaller percentage of the premium than those who are more highly compensated.

The most common variation on the premium co-pay is differentiation of employees by status. Insurance companies charge different premiums based on family status. For example, a four-level group might consist of a single-person household, husband and wife, parent and child, and family (spouse and children). The employer can elect to pay only for the employee (almost always the lowest cost) and require the employee to pick up the cost of a spouse or children. This has the advantage of treating all employees equally, but the disadvantage of requiring those with families to assume higher costs than single workers.

POLICY CO-PAY

This strategy differs from the premium option in that it changes the terms of a company's insurance coverage to require an employee to pay additional costs when he or she requires medical services. Companies can realize significant premium reductions when a plan, for example, requires a $15 employee payment for drugs, doctor or hospital visits as opposed to $5. For HMOs and PPOs, possible variations include requiring employees to pick up a greater share of out-of-network costs (50/50) vs. a more liberal benefit for in-network costs (80/20).

Another variation is to use a three-tiered drug coverage plan. Many already have different employee co-pays for generic and brand-name drugs. Some plans are adding a third tier known as "formulary" which includes many newer, more costly lifestyle drugs such as Vioxx or Viagra. The old two-tiered approach of a $5 co-pay for generic and $10 for brandname drugs now might also include $20 for drugs on the formulary list. Such lists are available from insurance companies and independent providers and frequently require insurance company preapproval to fill a prescription.

Whether an employer uses either or both co-pay approaches, the impact is the same: reduced employee compensation. But thanks to IRC section 125, premium co-pays (but not policy co-pays) don't have to cost employees too much extra: Section 125 allows employees to pay certain expenditures for health insurance premiums (and specified other insurance) on a pretax basis tithe company meets certain criteria regarding establishment and maintenance of a written plan. Paying these premiums pretax saves the employee federal income and Social Security taxes. (In some instances it will save state taxes as well.) For the employer, pretax premiums will help it save on its share of Social Security taxes.

SELF-INSURANCE

While cost-shifting strategies are valuable tools CPAs can recommend for all employers, large employers (from 500 to 1,000 employees) can consider an additional strategy. With self-insurance, the employer assumes some or all of the risk the insurance company traditionally assumed. In other words, the employer stands ready to use its assets for employee medical benefits. Under one form of self-insurance, an insurer steps in to provide coverage for catastrophic claims (terminal illnesses such as cancer or heart disease), with the employer paying either some or all of the noncatastrophic claims (broken limbs, routine surgery). This is known as "stop-loss coverage" and usually provides a dollar limit to the employer's exposure to either an individual claim or aggregate multiple claims. The benefit of not having to pay premiums for noncatastrophic coverage is that it is predictable--the company knows in advance what the premium savings will be. The problem is that it cannot know claims experience for certain in advance, although actuarial consultants or insurance companies can help with estimates. The choice of using this strategy depends largely on the employee census (age and family status), the employer's liquid assets and the costs of self-administering claims (although many insurance companies are willing, for a fee, to provide such services).

WHAT'S NEXT?

Whatever strategies a company adopts, CPAs should advise clients and employers to consider in advance both the impact on the bottom line and on employee morale as determining factors. CPAs can play a key role in helping businesses actively manage health insurance costs. While such costs can be a volatile employee-relations issue, addressing them openly and proactively will bring better results than simply waiting for health care expenses to become unmanageable.

STANLEY B. SIEGEL, JD, is president of HR&S Financial, a Philadelphia-based company offering insurance and personal financial planning services. His e-mail address is [e-mail].