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Carving Out Health-care Savings

April 1, 1995
Related Topics: Benefit Design and Communication, Health and Wellness, Featured Article
Thirty-eight million dollars is well above what most employers spend on health benefits each year. But that's what the National Railway Labor Conference in Washington D.C. was able to save in health costs, specifically those related to mental-health and substance-abuse treatment, thanks to the use of a benefits-management strategy called carve-outs.

Using a similar approach, US West, the telecommunications company based in Englewood, Colorado, was able to slash its mental-health costs by 25% without reducing the level of benefits to employees. Carve-outs also allowed the Orange County School Board in Orlando, Florida, to cut its mental-health tab in half, and they helped a manufacturing division of Dow Chemical in Free-port, Texas, reduce mental-health expenditures from $5.2 million to $1.4 million in five years—a 73% savings.

What, exactly, is this technique that's helping so many companies maintain the same level of employee benefits, while drastically cutting costs? Why are carve-outs becoming so popular? And what types of health costs are carve-outs most successful in controlling?

According to Leslie Schneider, managing consultant with Foster Higgins in Atlanta, the term carve-out refers to the practice of carving out or separating a particular class of health benefits—usually those that involve specialty health services—from the overall health plan in an effort to manage those benefits more cost-effectively. How? By applying managed-care strategies such as precertification, utilization review and case management.

Although traditional managed-care organizations such as HMOs and PPOs utilize case-management techniques, they're typically more concerned with the delivery of general medical services. They don't have the depth of expertise to manage specialty areas. And the major insurance carriers, according to Suzanne Gelber, senior consultant with Towers Perrin in Stamford, Connecticut, have been more concerned with processing claims, not reviewing specialty treatment to see if the care provided was appropriate and cost-effective. "The carriers are just beginning to get into the health business," she says. "For them to know all about several hundred mental-health diagnoses and how to handle them is pretty difficult."

This is why more and more employers are taking it upon themselves to carve out certain benefits and assign the management of them to a specialty managed-care vendor who knows what is involved in that type of care. "It makes sense that a company devoted to that kind of care is going to be more focused on it," Gelber adds. "They are going to have a better handle on how to manage, credential and contract with providers."

To date, carve-outs have been most effective in controlling the cost of prescription drugs and mental-health and substance-abuse services. In fact, Towers Perrin estimates about 80% of Fortune 500 companies have carved out EAP services, mental-health care, or both. This is because these services are relatively distinct from the rest of the medical delivery system. "The more interconnected a service is with the rest of the delivery network, the less likely it is to be carved out," says Howard Wizig, a consultant in the Kansas City office of Towers Perrin. The next generation of carve-outs is likely to manage such services as chiropractic and physical-therapy claims, diagnostic-testing services, high-risk pregnancy care, as-thma, diabetes and chronic-disease management. Why? Because these services also aren't heavily intertwined with primary-care services.

While the term carve-out is relatively new, the practice itself isn't. Dental plans, for instance, have been separate from the main medical plan in many companies for years. "Most people don't think of them as being carved out," Gelber explains, "when in fact, they are." Dental plans are carved out because they represent an area of specialty care and because the care providers represent a specialized group of health professionals. The organizations that administer the claims are equally specialized.

Part of the reason carve-outs are getting more attention lately is because more specialty-care providers are managing carved-out services. These providers have had to become very entrepreneurial and respond to the cost and quality concerns of purchasers because of a growing trend, at least in the managed-care environment, to rely more heavily on primary-care physicians. Why? Because they're cheaper. Fearing a loss of business, the specialists have banded together and created organizations that offer a level of expertise—be it in internal medicine or mental health—that's not available anywhere else. In essence, this is marketplace economics at its finest.

The second reason carve-outs have become so popular is, quite simply, because they work. When specialists are put in charge of managing specialty care, patient satisfaction increases and costs go down. By how much? The large mental-health vendors routinely achieve a 90% satisfaction rate while cutting costs for employers, on average, from 30% to 40%, Gelber says. And in prescription drug carve-outs, savings can be as high as 50%. For companies that carve out these services, the potential savings come at a good time, because for years the costs of mental-health and drug benefits have been rising at a higher rate than those of other health benefits.

Deciding what to carve out.
In looking for pieces of the benefits pie to single out, HR professionals should begin by analyzing their health-care data to see how they've used health benefits, including for what diagnoses and what kinds of care. These data will allow you to spot problems in quality, utilization or cost. If you notice, for example, that mental-health costs are rising faster than the costs of other care areas, you might want to consider carving out this benefit.

Which is exactly what the National Railway Labor Conference did last year. The self-insured organization which provides, among other things, health benefits to more than 200,000 railroad employees across the nation, could not cut benefits as a means of controlling costs because railway workers are unionized and the union would not accept reduced coverage. Besides, as many companies have discovered, cutting benefits can ultimately lead to other problems such as lower morale, sicker workers and declining productivity. The alternative, according to Joe Epstein, director of employee benefits, was to work with the union to find better ways of managing those benefits. How? By carving out some of the benefits and contracting with Value Behavioral Health (VBH), a specialty vendor based in Wilton, Connecticut, to manage them.

VBH not only serves as a gatekeeper to all mental-health services by precertifying railroad employees to use those services, but also manages a network of mental-health providers. Employees who use providers in the network are covered at a higher benefit level than those who go outside the network. The $38 million National Railway saved came from the combination of reduced per-visit costs VBH was able to negotiate with its care providers, and from the avoidance of inappropriate care (especially costly procedures) realized by having experts manage the recently carved-out benefits.

The next generation of carve-outs is likely to manage such services as physical-therapy claims, diagnostic testing and chronic-disease management.

Savings can be a big reason why some companies decide to switch to carve-outs, but there are other factors. Despite the savings US West has realized, cost wasn't the reason this organization carved out its mental-health benefits. Instead, it was because of access problems. In 1991, when the company consolidated four indemnity plans into one, HR professionals were concerned the chosen carrier would be unable to provide adequate mental-health coverage to all of its management employees in 14 western states. "In our opinion, the medical plan didn't have a large enough mental-health network," explains Keith Orton, regional director of mental-health services in the company's Portland, Oregon, office. So, the company carved out its mental-health coverage and contracted with a specialty vendor. Today, US Behavioral Health in Emeryville, California, manages these services for US West.

Because utilization is closely monitored, US Behavioral Health knows where to add providers to the network in order to make sure all employees have access to quality services. "Their sole purpose in life is to efficiently manage mental-health services for their clients," Orton explains.

Another factor in US West's decision to carve out mental health was because negotiations with its union, the Communication Workers of America, comes up this year and the company wants to introduce managed care into the health-benefits package provided to union employees. By carving out mental-health services for management employees ahead of time, "we're hoping we've created a plan that will look appealing to the bargained employees," Orton says.

Sandoz Pharmaceuticals in East Hanover, New Jersey, carved out its medical-surgical and mental-health benefits in January 1994 for yet another reason: as a way of getting employees used to the idea of managed care. According to Bill Flannery, director of benefits, employees had been used to a traditional indemnity plan in which all reasonable and customary charges were paid in full. Employees didn't have to go through a precertification and utilization review process, nor did they have to choose from a list of network providers.

In an effort to control costs, the company is planning to make the switch to a comprehensive managed-care program in 1995. As an interim step, Sandoz contracted with Intracorp in Plymouth Meeting, Pennsylvania, to review medical-surgical procedures, and with Value Behavioral Health for mental-health services. Both vendors serve the company solely as gatekeepers who approve procedures and length of stay. Employees are not—at least not yet—sent to providers in those networks.

"These vendors are charged with making medical judgements and determining the medical necessity of certain procedures," Flannery says. "We want employees to get used to the idea of case management before we change the whole benefit program on them. Though we have saved some money by carving out and managing those two benefits more closely, our primary reason for doing so was to create a cultural change in the organization."

There are lots of different ways to manage carved-out services.
Once you've decided what benefits you need to carve out and why, you must determine how you will manage those benefits. Since separate administration of carve-outs is what makes them so effective, choosing a qualified administrator is crucial.

There are essentially four ways to take advantage of carve-outs. The easiest way to manage carve-outs, and one that is mostly transparent to employers, is to contract with managed-care organizations that have already carved out specialty services. They do this by either creating their own internally specialized services or by contracting with outside vendors. Either way, the services are managed by experts.

An HMO may carve out radiology and laboratory services, for example, and instruct their doctors to use only pre-approved radiology and lab vendors. Because this is done internally, there is no impact felt by employers or their employees. However, because costs can be controlled, purchasers get the financial and quality benefits of carved-out services without having to manage them. According to Gelber, about 10% of employers use HMOs that have internally carved-out services. Because they are often invisible to purchasers, you may already be taking ad-vantage of them without knowing it.

The second and most difficult way to carve out benefits is by creating and contracting with your own network of providers. This requires the HR department to identify, credential and manage the physicians and vendors in the network, as well as handle all the precertification, utilization review, case management and claims processing. Direct contracting is by far the most cost-effective route because it eliminates costly intermediaries. However, the administrative burden on the HR function is enormous. "Increasingly, employers who had been direct contracting are not doing it anymore," Gelber says, "because it's a pain to administer." Only about 10% of employers who use carve-outs have gone the direct-contract route.

About 40% of companies are taking advantage of carve-outs by using specialty services managed by major insurance carriers. Under this kind of arrangement, you could either opt to use the carve-outs offered by your own carrier—one-stop shopping, as it were—or carve out the benefits and assign them to separate carriers. You may choose Travelers Insurance, for example, for your indemnity coverage and Aetna for your medical point-of-service plan. The problem with using the same carrier for all carved-out services is that the account manager who handles your account will then be responsible for both the indemnity and specialty coverage. "Very often," Gelber explains, "employers are not happy with that arrangement because account managers can't know enough about all specialty areas. They aren't dentists and pharmacists and mental-health clinicians as well as account executives."

The last, and one of the most popular ways to manage carve-outs, is to use a specialty managed-care vendor like VBH or US Behavioral Health. These organizations are in business solely to provide cost-effective, high-quality specialty care for their clients.

Most companies, regardless of the way they decide to manage the carve-out, offer the carved-out managed-care services to employees as a choice that's available in addition to their regular benefits coverage. Employees are then of-fered financial incentives to use the specialty network.

Managing carve-outs challenges HR professionals.
As you might imagine, there are several challenges inherent in managing carved-out services. First and foremost, you must make sure that specialty providers are able to work within your cost and quality requirements. Union Carbide Corp. in Danbury, Connecticut, learned this lesson the hard way when it contracted with a specialty vendor to carve out psychiatric and substance-abuse services in 1988.

According to Ed Hoefer, associate director of benefit plans, during the first year of the carve-out, costs for psychiatric services dropped significantly and the company was happy. By the end of the second year, however, costs had jumped up 40% and HR managers had a difficult time getting the vendor to account for the increase. After some investigation, Union Carbide found the vendor wasn't properly managing the discounts it had negotiated with providers. For example, a per diem hospital rate that should have been $400 was actually being paid out at $800. Other claims were not being paid at negotiated rates because of problems with the vendor's computer system. "Basically, the services were not being managed the way we were promised they would be," Hoefer says.

After working with the vendor and searching, mostly unsuccessfully, for ways to better manage costs, Union Carbide fi-nally gave the vendor an ultimatum: guarantee that costs would be maintained at a certain rate per em-ployee per year or lose the contract. "Because the vendor wanted our business, they agreed, and costs dropped like a rock the next year," he says.

Yet this created an-other problem. "We no-ticed a drastic drop in admission rates and the average length of stay which made us wonder if the vendor was limiting access to necessary psychiatric care," Hoefer explains. "We wanted to control costs, but we also wanted to get people well."

About 40% of companies are taking advantage of carve0outs by using specialty services managed by major insurance carriers.

Eventually, Union Carbide worked with its vendor to draw up a detailed business plan that included a series of clinical quality measures. After five years, the company and its employees are finally happy with the arrangement. Costs are down—Union Carbide paid $228 per employee per year for mental-health services in 1994 compared to $326 in 1989—and patient satisfaction is up.

Given his experience, what advice would Hoefer have for other companies that wish to carve out psychiatric services? "Develop measurable standards," he says. Gelber agrees, adding that vendors should be willing to pledge a percentage of their fee against the attainment of administrative, clinical and financial standards.

Another trick in managing carved-out services is getting the specialty vendors and primary-care physicians to work to-gether so referrals can be made between the two groups. If an employee is undergoing treatment for cancer, for example, he or she may need some support from mental-health therapists. The primary-care doctor who is covered under the general medical plan needs to know the specialty network exists. "This is tough because sometimes the primary-care physicians are not interested in knowing who to refer [patients] to," Gelber says, and unless the carve-out vendor has been instructed to share appropriate information with medical providers, they may neglect to do so.

From an internal standpoint, the biggest challenge with carve-outs is communication. Teaching em-ployees what managed care and specialty health-care networks are all about is tough, but as Epstein from the National Railway Labor Conference ex-plains: "You can't over-communicate about managed care." Extensive communication with managers also is important because they are the ones who have to approve and sell the concept of managed care to their employees.

In the end, what is the biggest impact of carve-outs on the HR function itself? "It creates a different sort of function," Gelber says, one that is focused on vendor management and data analysis. Carve-outs require analytical, coordination and management skills that fit well with the new customer-oriented generation of HR people. When carve-outs are done right, costs decline, care improves, quality monitoring improves and there's a broader spectrum of care covered by the benefits plan. Companies can't help but come out ahead.

Personnel Journal, April 1995, Vol. 74, No. 4, pp. 38-48.

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