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Employee, Cover Thyself

Employers agree that defined-contribution plans can solve the problem of rising health-care costs, but no one wants to be the first to implement them.

April 1, 2000
Related Topics: Health and Wellness
As director of human resources for the University Center for Atmospheric Research in Boulder, Colorado, Bob Roesch manages health benefits for 1,200 employees. His company's medical costs have increased an average of 8 percent annually over the last two years, and he anticipates similar increases in 2000. Is he worried? "We haven't started to panic yet." What will he do if costs keep rising? "We'll probably absorb them because we're in a tight labor market and are fairly protective of our employees."

Roesch is hardly unique. Although medical costs are again inching into the double digits and medical inflation is three times higher than general inflation, employers are more likely to grin and bear current cost hikes than to pass them on to employees because they don't want to risk alienating workers in a tight labor market. In fact, almost three out of four benefit specialists responding to a recent Deloitte & Touche survey said that although rising medical costs are their top concern, their benefit strategies are currently being driven by workforce issues, not cost.

"Attracting and retaining the best employees has now become serious business," explains Dennis Wootan, director of benefits administration with Northrop Grumman Corp. in Los Angeles. "As a result, employers are feeling pressure to provide the best perks ever, from retirement packages and stock option plans to affordable, quality health care." Instead of passing cost hikes on to employees, employers are trying to control future increases through such things as disease-management programs, pharmaceutical cost control, and plan redesign.

While this strategy certainly makes sense, employers may be gaining short-term advantages at the expense of much greater long-term pain. Why? Absorbing health cost increases while tweaking the current system does nothing to change the fact that the system itself is fundamentally flawed. After all, one of the reasons medical costs keep rising is that consumers are separated from purchase decisions, so there is no way to hold them accountable for costs or for them to have any significant influence on delivery.

"There is no connection between who consumes, pays, and provides for health care," explains Philip Lathrop, national adviser for managed care with Booz-Allen & Hamilton Inc. in New York City. In such a highly intermediated industry, it's almost impossible to get effective cost controls or quality service because there is no way for demand to match preference.

Furthermore, although employers have worked diligently with health plans and providers to control costs, these efforts have been focused on the supply side of the industry. Until employers are able to influence how health care gets financed and who makes purchase decisions, "health care demand is likely to remain a bottomless pit," Lathrop says.

Dismal as it may sound, there is a potential solution on the horizon, and it is one that many HR professionals and consultants secretly acknowledge is long overdue. Unfortunately, because of the tight labor market, most employers are presently too chicken to implement it.

What is this magic bullet? It is a defined-contribution model in which companies give employees medical vouchers in order to purchase their own health benefits. Vouchers are based on the belief that consumers -- not their employers -- are in the best position to know what kind of health care they need and how much they want to spend for it.

On the surface, it may sound like a radical idea to take health-benefit decisions away from employers. And, yes, many changes are necessary for vouchers to become a reality. But the fact of the matter is this: Putting accountability for purchasing decisions into the hands of consumers may be the only way to reform the system and bring medical costs under control on more than a temporary basis.

How do vouchers work?
In its purest form, a defined-contribution health-benefit plan would work this way: Employers would give each employee a set amount of money annually with which to purchase health-care coverage. Employees would then shop around for plans that meet their individual health needs, probably by using online services to review plans and obtain cost information.

Under the voucher system, employees could choose to purchase less expensive plans and put the difference into some type of medical savings account, or add personal funds to the employers' contribution for more deluxe coverage. Although defined contributions get employers out of the arduous business of administrating health care, employers would still foot the bill. It is not a cut-and-run strategy.

In theory, the defined-contribution approach sounds simple, but there are hurdles to cross before such plans could become reality. For starters, the costs of health insurance would have to be fully tax deductible for employees. Right now, if an individual were to receive $5,000 for health care from his or her employer, that employee would have to pay taxes on the total, reducing the net amount available for health care.

Another problem is that insurance underwriters would have to find ways to calculate risks that are outside of employment groupings.

"The insurance companies are terrified of this because most of their business now comes in the door 10,000 people at a time," says David G. Knott, partner with Booz-Allen & Hamilton. Still, Knott believes there are lots of ways for insurance companies to provide group rates, including affinity groups, clubs, organizations, and health purchasing cooperatives that employees could join.

In addition, the reluctance of insurers to cover people with such things as pre-existing conditions would have to be addressed, possibly through mandated community ratings or some other form of government oversight.

While the tax code and insurance industry do not yet support a pure medical voucher system, some employers are experimenting with a voucher-style approach in which employees are given an allowance and allowed to choose from an array of plans selected by the company. These companies include Xerox and Carlson Cos., a travel and food service company based in Minneapolis. In both companies, when plans raised their rates, employees migrated out of those plans in droves, according to a recent article in The Wall Street Journal.

Why are vouchers needed?
A defined-contribution plan would address many of the problems that are inherent in the current system, including:

Lack of accountability. A health-care forum sponsored last August by PacifiCare in Denver brought together employers and health-care leaders to discuss critical issues facing the industry. While many concerns were voiced, the one issue employers agreed on was that the disconnect among purchasers, providers, and consumers removes individual accountability for informed purchase and consumption of health care.

Because a defined-contribution plan would put health-care purchase and selection decisions into the hands of consumers, accountability would naturally increase. "If you've got skin in the game, you're likely to be more involved in health-care decisions and do your homework," explains Kenneth Sperling, a principal with Hewitt Associates in Norwalk, Connecticut.

Escalating costs. The current health-care system is financially inefficient for two reasons: 1) because demand is not able to influence supply, and 2) because the current system is laden with administrative costs.

Under a defined-contribution plan, costs would likely be brought under control -- and might even be lowered -- because the cost of administration would be reduced. Consultants from Booz-Allen estimate that approximately $18 billion of current spending is up for grabs: the $5 billion the health plans spend in sales and marketing; the $3 billion paid to benefits consultants for design, selection, and other services; and the $10 billion employers spend on internal administrative costs -- all of which would be eliminated in a voucher-style system.

Complex administration. When employers first began offering health-care benefits to employees after World War II, they were relatively cheap and easy to administer. As costs rose and the system became more complicated, the benefits administration side also grew in complexity.

Today, many employers are fed up with the administrative headaches that are associated with health care, especially since health benefits are not part of most companies' core business. Under a defined-contribution system, employers would still pay for health benefits, but all decisions related to plans and providers would be made by employees.

Employee dissatisfaction. It's not just employers who are fed up with the current system; employees, too, are dissatisfied. They don't like being told which plan they can use, which provider to go to, and which benefits are covered. The one-size-fits-all strategy used by many employers is irksome to employees who want more customized benefits. After all, a 25-year-old male has very different medical needs than a 50-year-old woman. Under a voucher system, employees would be given complete choice and control over their health-care spending.

Despite the advantages of moving toward a defined-contribution model, not everyone is supportive of this approach. "I don't think a defined-contribution model will solve the root cause of [today's health care] issues," says Tom Dameron, director of health and welfare benefits at US WEST, based in Denver. "Right now there are tremendous clinical quality issues that everyone can work together on."

Barbara Adachi, principal for the Human Capital Advisory Services Group at Deloitte & Touche in San Francisco, agrees with Dameron. "Employers are the champions of high-quality care and access, and that gets lost in the voucher system," she says.

Furthermore, Adachi continues, "Employers have to look at benefits in light of company culture and the message they want to send to employees. If they want to attract and retain the best talent, they might not want to focus solely on health-care costs when making coverage decisions."

But those who don't approve of the defined-contribution model may soon be in the minority. Interviews conducted by Booz-Allen with benefit managers at 30 companies revealed that all but two were supportive of the defined-contribution model. Those who were reluctant were from traditional, paternalistic companies. "The people we talked to were supportive of the defined-contribution model, but none of them wants to be the first company to offer such a plan."

What might prompt a move to vouchers?
Although benefits managers are hesitant to support vouchers at this point, there are factors that would induce many of them to make the shift.

The first involves tax code changes. According to a recent study by Hewitt Associates, 40 percent of employers say they would support legislation providing tax credits for health coverage as a way to allow them to get out of the business of providing direct health-care coverage.

But while tax credits may pull employers toward a defined-contribution approach, the fear of liability may push them even more powerfully. Currently, there is talk on Capitol Hill of creating legislation to make employer plan sponsors subject to malpractice lawsuits. Over a third of employers responding to the Hewitt survey said that should this happen, they would probably get out of the business of providing health-care coverage.

Legislative changes aside, more employers will probably consider a defined-contribution plan when one of the biggest barriers to health-plan changes is eliminated: the tight labor market. "Employers tell us, 'Sure, we'd love to move to some sort of defined-contribution system, but don't expect us to move first because we're having trouble getting employees,'" Knott says. He believes that a general recession in the economy could quickly and decisively change employer attitudes toward health-care coverage.

Converging forces may smooth the way.
Even without changes in the tax code and labor market, there are already forces at work that provide support for a move to a voucher-style system. To begin with, employers have gotten used to outsourcing those activities that are not central to the business, including health-benefits administration. It's just a short step from outsourcing health-care administration to eliminating it altogether.

Second, employers have been speaking the mantra of employee empowerment for years, believing that people most able to make good decisions are those closest to the problem. Why should it be any different with health care? Though some believe that the medical system is too confusing for employees to decipher on their own, employers' experience with defined-contribution pension benefits has shown that when it comes to their own welfare, employees are willing and able to take on higher levels of responsibility.

Furthermore, for a consumer-driven system to work, employees would need access to up-to-date health information. This is something the Internet now provides. "Health-care-content sites are one of the top three in terms of Internet popularity," Sperling says. "For the first time, we're seeing people walk into their doctors' offices knowing more about their conditions than the doctors do." Moreover, 86 percent of large employers have adopted Web-based health-care programs in order to administer health-care benefits, coordinate delivery, and disseminate health-related information, according to the Washington Business Group on Health.

Because consumers appear to have embraced the Web as a source of health information, many online companies are being formed on the bet that companies will make the move to defined-contribution plans and put all health-care decisions into the hands of employees. One of these new online vendors is The site, which went live on March 31, allows individual and small groups to evaluate and purchase health plans.

"We've created a patent-pending decision technology that decodes health-care terminology and makes the purchase process easy," explains Eric Grossman, CEO. Eventually, the site will allow individual purchasers to be pooled together into risk groups, making it possible for them to receive more favorable risk ratings.

Another force that may facilitate the move to defined-contribution plans is the fact that the medical community is behind the idea. Defined-contribution plans would "effectively take the third party out of the picture and return the decision-making to the patient and physician," explains William H. Mahood, a gastroenterologist and trustee of the American Medical Association, based in Chicago.

What can employers do?
While the move to medical vouchers is not likely to occur until the labor market opens up, there are a few things that employers who support this approach can do in the meantime.

The first is to continue to demand quality data from health plans. Although standards have been developed by the National Center for Quality Assurance in order to evaluate the quality of care, only 16 percent of employers are monitoring quality-of-care indicators, according to a Deloitte & Touche survey.

"You have to decide which criteria you'll use to select a health plan, communicate that criteria to the plan, and then stick to the formula," Sperling says. Why is this important? Because consumers have to be able to tell the difference between a good plan and a bad one, and that will never happen unless plans are held accountable for gathering quality data. "We can't move to a system where consumers are more accountable for health care unless they have decision support tools," Sperling explains.

Another thing that employers can do is to experiment with voucher-style programs in which employees are given a choice of different plans but not the money to purchase them directly. This affords employees a chance to start getting comfortable with making coverage decisions.

Are defined-contribution plans a given at this point? Not necessarily, but they do offer a potential solution to the lack of accountability, high cost, and administrative hassles that accompany the present health-care system. Knott and Lathrop believe that the defined-contribution wave will break no more than three to five years from now, and that employer-managed, defined-benefit health plans will be nothing but a memory within 15 to 20 years and probably much sooner.

Employees are already used to purchasing their own homeowner's insurance, auto coverage, life insurance, and retirement-investment vehicles. Why not health insurance? It's a question that more employers are bound to be asking.

Workforce, April 2000, Vol. 79, No. 4, pp. 34-42.

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