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Is Choosing a Defined Contribution in Health Care Taking the Radical Route?

The option, which gives employees more autonomy, could revolutionize employer-provided health benefits, proponents say.

September 28, 2012

Employees at Christensen Group Insurance, who previously had been given only one health plan option, sat down to a banquet when they enrolled for 2012.

Working their way through an online program, the employees perused eight health insurance plans. To make their purchase, they were provided a lump sum, also called a defined contribution by proponents who say the approach could revolutionize employer-provided health benefits as 401(k)s did with retiree benefits.

Providing every employee a set amount, rather than subsidizing the benefits more indirectly, makes the price tag more visible, says Sheila Nordquist, senior employee benefits consultant at the Minnetonka, Minnesota-based insurance broker. In 2012, she says, the pattern was clear: Employees gravitated toward higher-deductible, lower-premium policies compared with their prior health plan.

"I thought I was the expert," Nordquist says. "I didn't really know what the employees wanted to buy."

Until now, the defined contribution approach has been pioneered primarily by a limited number of employers, typically on the small side such as Christensen Group, with 75 people on its payroll. The insurance marketplaces needed for employees to shop, such as My Plan by Medica used by Christensen, have been relatively scarce. But the Patient Protection and Affordable Care Act could accelerate the defined contribution model for several reasons, benefits experts say.

Beginning in 2014, insurance applicants can't be denied based on their history of cancer, heart disease or other pre-existing health conditions. Moreover, the law creates public exchanges, introducing the concept of shopping for insurance online, much as Americans already purchase airfare or music, says Ken Sperling, national health exchange strategy leader at Aon Hewitt. In late September, the Lincolnshire, Illinois-based consultant announced that more than 100,000 employees would be enrolling through its newly created private exchange, starting this fall.

Sperling says forces have sufficiently aligned to start severing workers' dependency on their employers for health insurance. "The coverage becomes portable," he says. "Someone leaves their company, they lose their subsidy. But they can keep their insurance."

Still, the first employers to take the plunge face numerous uncertainties, among them whether their workers can shop wisely, says Andrew Webber, CEO of the National Business Coalition on Health, a not-for-profit organization in Washington.

"Going to a defined contribution in health care is a radical departure," he says. "It gives all of the responsibility over to the employee. What if the employee makes poor decisions as they have with 401(k)s, perhaps?"

Along with Aon Hewitt, other large human resources consultancies are jockeying to fill what they perceive as an emerging business opportunity. Officials at New York-based Mercer and Extend Health Inc. in San Mateo, California, which was recently purchased by Towers Watson & Co., also report exchanges in the works.

Unlike My Plan by Medica, which has about 16,600 members and offers policies only from the Minnetonka, Minn.-based insurer, Aon Hewitt and Extend Health officials say their exchanges will incorporate multiple insurance providers. Aon Hewitt leaders have reported that plans will be offered by nine national and regional carriers, including Cigna and UnitedHealthcare.

Extend Health already operates a private exchange for Medicare-eligible retirees, and has helped 550,000-plus since 2006 to enroll in private Medicare Advantage plans, prescription and other supplemental coverage, CEO Bryce Williams says. The defined contribution approach also has been proposed for traditional Medicare by Rep. Paul Ryan, R-Wisconsin, who advocates for transitioning Medicare recipients to a voucher model—one that the Republican vice presidential nominee describes as premium support—to offset the program's rising costs.

But will U.S. employees embrace more autonomy? Among those Americans familiar with Ryan's Medicare proposal, 49 percent oppose the idea versus 34 percent in support, shows a Pew Research Center survey involving 1,005 adults in August.

A survey conducted this past spring by the National Business Group on Health in Washington also revealed signs of nervousness. Slightly more than half, 53 percent, said they wouldn't be able to locate equal or better health coverage on their own, show the results, involving 1,545 employees from organizations with 2,000-plus workers.

Neither does a lengthy menu of insurance choices necessarily help consumers, says Barry Schwartz, a psychology professor at Swarthmore College in Pennsylvania and author of the book Paradox of Choice: Why More Is Less. Studies involving far less complex decisions, such as the purchase of pens or gift boxes, find that people mentally max out once choice expands beyond six to eight options, he says.

Employers also should keep in mind that people tend to focus more on the short term and can be unrealistically optimistic, Schwartz says. If they view their own health as above average, that bias might influence their insurance selection, he says.

For example, they might opt for a lower premium, high-deductible plan "rolling the dice that they won't get sick," he says.

At Aon Hewitt, which is piloting an exchange with its own employees, an opposite pattern has been noted—more employees than anticipated have selected richer coverage tiers. "There's a natural tendency for risk aversion," Sperling says. "So people will tend to buy a little bit more insurance than they might need."

Among Christensen Group employees, however, the greatest number have chosen plans with deductibles ranging from $3,250 to $5,250, Nordquist says. (The employees were offered only high-deductible plans.) Just eight of the 52 employees who enrolled in health coverage selected the $2,250 deductible that most closely mirrored the sole plan offered in 2011.

To reach their selection, Christensen employees worked their way through online decision-making software, developed by Minneapolis-based Bloom Health Corp. About three dozen questions help pinpoint the employee's insurance needs and their financial risk tolerance, whether that's generous prescription coverage or low monthly premiums, says Kevin Kickhaefer, Bloom's head of sales and market development. "It's essentially like a Myers-Briggs for health care," he quips, referring to the widely used personality assessment.

Once the employee answers and approves that priorities list, the software generates a list of recommended plans. "What we are trying to really do is to simplify a complicated decision," Kickhaefer says. Employees also can bypass the Internet entirely by contacting the call center, staffed by licensed insurance brokers.

Since Christensen employees are already accustomed to high-deductible plans, they may have selected even higher deductibles in 2012, figuring that they already had accrued hefty balances in their health savings accounts, Nordquist says. Asked about the risk of underinsuring, she didn't seem particularly worried.

"In general that's a concern, but I'm not sure that should be my concern as an employer," she says. "We all have to be financially responsible for ourselves."

But she also plans to monitor purchasing decisions moving forward. Will employees who selected the highest deductible policies make the same choice in 2013?

Setting a defined contribution doesn't in and of itself protect employers against rising health costs, says Paul Fronstin, director of the health research program at the nonprofit Employee Benefit Research Institute in Washington. Moreover, Fronstin adds, "If the labor market rebounds, they may need to increase contributions to be competitive."

But exchange leaders counter that placing decision-making clout in the hands of workers will introduce badly needed competition into the health system. A Bloom Health analysis, based on the experience of 5,424 exchange enrollees in late 2011, found that they spent 22 percent less in premiums on Bloom's private exchange compared with the natioaverage.

Williams of Extend Health, which plans to launch its exchange for active employees in 2014, predicts that the insurance market will soon be transformed beyond recognition.

"When you have guaranteed-issued coverage for all, you have one supergroup for pooling—same as in Medicare," he says. "The [insurance] carriers are going to be more willing to be more price-competitive, because they are going to have to compete for each individual consumer."

Charlotte Huff is a Workforce contributing editor based in Fort Worth, Texas. Comment below or email editors@workforce.com.