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Controlling group medical costs.

Controlling Group Medical Costs

If you ask your financial officer to give you the total cost of all employee benefits, you will be surprised at two things: how long it takes to get all the costs and how much they amount to. Employee benefits typically account for 25 to 40 percent of the payroll. They are often the second highest expense after payroll. Yet, for something so costly, they are frequently not well managed. [1]

Employee benefits are complicated to understand, heavily entwined in government regulations, much in demand by employees, and subject to cost increases beyond the normal control of managers.

A recent survey shows that the average cost of medical insurance (the most costly of the employee benefits) per worker is $2,748, up 16.7 percent from 1989 and representing 5-10 percent of payroll. One need not point out the staggering increases in medical care costs to the medical profession. Hospitals and medical clinics are feeling the same cost increases as everyone else in this respect. [2-6]

In a typical group medical plan, costs are allocated between administration, benefits paid to the health providers, and reserves.

Plan Administration

The administration of a plan includes verification and payment of claims, billing, additions and terminations of participants, and reporting. The percentage of the total plan cost allocated to administration averages 10 to 15 percent, higher in smaller plans and lower in larger plans.

Good administration is important for several reasons. It is usually how participants and benefit managers measure the quality of the plan (i.e., timeliness of changes and billing, claim processing, handling of questions and complaints, etc.). A second, and often more crucial factor, is the accuracy of claim payments. A plan administrator who overpays claims, often to demonstrate rapid processing, can be an enormous hidden expense to the employer.

Cost of Benefits

The actual cost of benefits (physician, hospital, prescription drugs) makes up 70 to 80 percent of the total plan cost. This is why "shopping" for better rates is often a waste of time. An employee who incurs $10,000 of legitimate medical expenses costs the same regardless of who the administrator or insurance carrier is.


The final segment is the reserve or pool of money that is set aside in some plans as a contingency against future losses. Usually, this is considered the employer's money, and in some cases it is even held by the employer. In a new plan, a higher portion of the cost is allocated to create the initial reserve fund. After the plan has been in effect for several years, and if claims have been running as expected, very little additional charges are made for reserves. As we will discuss later, some plans do not require a reserve.


There are several ways to set up a group medical plan. One of the most common methods, particularly for smaller employers, is a fully insured plan. Small employers are often pooled into what is called a multiple employer trust (MET). Plans with around 50 participants begin to have enough credibility to use their own experience to estimate future costs. However, their large claims will still be insured or "pooled." This is why the experience of all the plans administered by an insurance carrier is reflected in their rates.

The advantage of an insured plan is its stability and the complete transfer of risk. A large financial institution agrees to accept the risk so the employer will never face a huge claim loss. The disadvantage of a fully insured plan is that a particular employer can have virtually no claims but still incur a rate increase because the experience of the other groups being managed by this particular insurance carrier is unfavorable.

Medium and larger sized employers have several options. First, they can use a fully insured plan as described above. Many still do. Second, they can move into partially insured or self funded plans. There are several models from which to choose. An insurance company will provide administration services only or a minimum premium plan. All but the largest claims are reimbursed directly by the employer. Larger companies can also use a third-party administrator and separately insure large claims that exceed a certain limit (for example, $50,000 per claim or 125 percent of last year's total claims). This is called "stop loss" and is available on either a specific (per claim) or aggregate (total claims) basis. Very large employers may choose to fully self-insure their plan benefits.

Good third-party administrators offer an efficient way to pay claims and handle the general administration of a medical plan. However, beware of the many small administrators with minimal financial backing. If the administrator goes out of business or bankrupt, your group medical plan will turn into a nightmare overnight. When you pick an administrator, find out what computer system they are using and what other administrators use a similar system in case you have to move quickly. Also find out what their average turnaround time is for claims. Talk to some of their customers before making a decision to use their services. Review their reporting carefully and verify their liability coverage.

HMOs have been an effective method of containing increasing medical costs, but sometimes at the expense of the physicians and hospitals providing the benefits. PPOs, which, in contrast to HMOs, do not transfer risk, but rather agree to provide services at a reduced cost, are another method. Some employers use all three approaches. Some employers use all three approaches. Because the heart of cost containment in medical care lies in careful utilization of benefits, this is really the place to look for savings.

Employers have several options in dealing with their group health costs. The first is to carefully screen whom they hire. Preemployment screening is critical, for the employee as well as his or her dependents. Good screening saves money. In this respect, it might make sense to have a 180-day waiting period of the group plan and use medically underwritten interim coverage for the first six months. This will automatically tell you if your new hires are reasonable risks for medical insurance.

Second, start an effective wellness program. Help your employees change their life-styles to minimize the use of medical care. Help employees stop smoking, lose weight, get into exercise programs, and eat nutritious food. Wellness programs have the potential to reduce medical claims by up to 40 percent. [7-9]

Third, get timely reports from your medical insurance plan administrator so you can find out where your money is going. This is so obvious you would think it not worth stating, but it is surprising how few employers get accurate reports on claims.

You need to see, at least quarterly, a statement of who is incurring claims (i.e., males or females, employees or dependents, new employees or oldtimers, etc.) for what type of claims (i.e., hospital, physician, drugs, cardiovascular, pulmonary, accident, etc.). Only by reviewing such data can changes in plan design be made to help you control costs.

Cost shifting offers an opportunity to save money, though not as much as you might think. Raising the deductible shifts some of the cost to the participants, but most employers will find that the total savings reflected in the difference between a $100 and $300 deductible plan is probably not more than four or five percent. Shifting the premium cost (e.g., dependent coverage) to the employee is effective for the first year, but often backfires. Employees, thinking they are now owned the benefit because they are paying all the cost, begin to utilize the benefits more than ever. Also, as more of the cost is shifted, more employees will elect to discontinue the coverage and those who use the coverage least will be the first to leave. This results in a greater concentration of high-risk participants in the plan, which pushes up costs even more.

Utilization review procedures have been shown to produce savings on larger claims where big dollars are involved. In contrast, second surgical opinions seldom provide substantial savings and may actually cost more than they save.

Cafeteria plans, an old idea, are beginning to catch on. The employer offers choices in levels of benefit coverage. For example, the "core" medical plan might provide a $1,000 deductible wity a 70/30 coinsurance to $5,000 (a maximum out-of-pocket expense to an employee of $2,500). The core plan would not provide anything but a basic medical care plan, but the cost would be zero to the employee, with some cost for dependent coverage. Each participants could then "buy" options for more coverage. For example, a $500, $250, or $100 deductible; an 80/20 coinsurance option at either $2,500 or $1,500; group term life insurance equal to one, two, or three times salary; accident coverage of $300 without a deductible; short term disability coverage; etc. Each option has a cost and each participant would have the right to purchase any of the options.

The second part of the cafeteria program involves giving employees a monthly "allowance" to spend a benefits or to take in cash. A cash benefit is taxable, of course. Some employers do not permit the cash option.

The cafeteria concept requires good benefit communications, but modern programs make administration of these programs much easier today. The act of choosing benefits helps employees understand the relative cost of benefits and encourages them to buy only the benefits they think they will need.

Allied Considerations

Historically, insurance carriers required group life insurance as part of a medical plan and many still do. However, these are two entirely different benefits and should be shopped for separately. The cost of life insurance is fairly low because the probability of death prior to retirement is very low. Accidental death benefit (ADB), or double indemnity, is frequently added, although for younger employees, the cost of ADB is as much as the base group term life rate. Rates are very competitive among carriers. If you are required to have a minimum amount with the medical carrier, get quotes from other carriers for any excess amounts. You can break out the ADB cost and shop for it separately as well. If you have a qualified pension plan, it may be less expensive to include a death benefit inside that plan, particularly for amounts over $50,000.


[1.] Geisel, J. "Health Benefit Tab Rises 19% to

New High." Business Insurance

23(50):1,36, Dec. 11, 1989.

[2.] Employee Benefits, 1988. Washington,

D.C.: U.S. Chamber of Commerce, 1989.

[3.] "Employee Health Benefits Costs Rose

16.7% in 1989, Despite Managed Care,

Cost Containment Efforts." Spencer's Research

Reports, Aug. 3, 1990.

[4.] "Costs Create Tensions at Bargaining

Table." Employee Benefit Plan Review.

44(11):64-6, May 1990.

[5.] "Medical Plan Costs Rise 20.4%:Higgins."

Employee Benefit Plan Review 44(11):68-71,

May 1990.

[6.] Caudron, C., and Rozek, M. "The Wellness

Payoff." Personnel Journal 69(7):55-62,

July 1990.

[7.] Miller, J. "Good for Insurers' Health."

Best's Review 89(12):62-64,95, April 1989.

[8.] Schachner, M. "It's a Fact: Wellness Cuts

Health Care Costs." Business Insurance

23(16):32, April 17, 1989.


Michael E. Negley, CLU, is a consultant on corporate insurance and employee benefits with Perry, Compton, and Negley, Tampa, Fla.
COPYRIGHT 1991 American College of Physician Executives
No portion of this article can be reproduced without the express written permission from the copyright holder.
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Title Annotation:administering employee health benefits plans
Author:Negley, Michael E.
Publication:Physician Executive
Date:Jan 1, 1991
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