November 2000 (Vol. 1, No. 5)
Defined Contributions: Future or Fad
by Robert Stone-Newsom and Chris Queram

Robert Stone-Newsom, PhD, Senior Scientist, Wisconsin Network for Health Policy Research
Chris Queram, MPH, CEO, Employers Health CareAlliance Cooperative

The resurgence in health care costs has prompted a renewed interest in an idea that dates back to the early days of managed competition. Simply stated, the question many employers are beginning to ask is "Why don't we get out of the health care purchasing business and simply hand over to the employee the money we normally pay for health benefits -- let them decide how to spend their health care dollars?" The idea of giving an employee a defined contribution (cash) instead of first defining and then purchasing a benefit (insurance) goes back to at least the late 1970s. Generally, a defined contribution plan involves the employer giving the employee a set amount of money with which they can purchase a health plan, insurance or other benefits. Traditionally such cafeteria or flexible spending accounts provided a limited range of employer-chosen spending options. Importantly, the employer selects the menu ahead of time. Recently, however, employers and some of the large benefit-consulting firms have been exploring a more radical idea. Why not allow the employee, using funds provided by the employer as well as their own money, to evaluate and select their own plans from the health care options available in the marketplace? Basically the employer will continue to provide an economic contribution as always but will turn over the responsibility of choosing health benefits and options to the employee. Over 46% of Fortune 1000-level employers were interested in this idea according to a KPMG 1 2000 survey. This idea of "turning over of responsibility" has caught the attention of all the health care players -- employers, employees, providers, insurers, policy-makers and unions.

The status quo:

Since WWII the defined benefit plan has become a familiar health care payment option to the nearly 155 million of us who receive health care expense coverage as part of our employment package. In its basic form the employer offers one or more health plans with a stated level of benefit. Either the employer or the employer and the employee make premium (the cost of coverage) payments for the stated benefit package. Of those who offer health care, about 60% of employers purchase the benefit package as insurance while the rest "self insure"— pay for their employer health care costs as they occur. Self-insurers often cover the possibility of calamitous loss by also purchasing "stop- loss" insurance. Defined benefit plans involve the employer and often an agent or benefits consultant in choosing among health plan packages that offer different benefits at different premium structures. Larger employers and those who belong to purchasing alliances either directly negotiate with the providers of services or negotiate directly for better rates through insurers. Employers have little choice but to get involved in a selection and evaluation process no matter how they pay for the defined health care benefits they offer. They have to try and pick the best deal both for themselves and their employees. Employers are in part "compensated" for their efforts through substantial tax incentives ($100 billion annually) and shielded from much legal risk by ERISA2 rules. Some employees and employers resent the paternalistic role such evaluation thrusts on them; however other research,3, 4 their employers. Additionally indicates employees appreciate the advocacy and premium negotiation roles of the migration from traditional insurance (8% of enrollments) to other plan types such as PPOs 5 (at 22%), HMOs (at 29%), and POS (at 22%) has not only failed to stem rising health care rates but appears to have increased employee dissatisfaction as well. Employee dissatisfaction, in a booming low unemployment economy, is a greater problem for employers then the disputable cost savings offered by any of the new managed care options. There is an obvious opportunity for a health care benefit scheme that increases employee freedom of choice, reduces employer involvement in the evaluation, negotiation and selection process, yet maintains the employment perquisite of health benefits we all accept as our due. If the defined contribution is that opportunity, is it a good idea?

What are the issues:

Do employees really want to choose their own providers and benefits? Will employees spend the money wisely? Aren't employers better situated to make these evaluative choices or to negotiate prices and benefit levels? If consumers represent themselves individually rather than as large employee pools, won't providers become even less responsive to improving their outcomes and quality? Won't insurance rates rise as risk pools are splintered? Is there enough consumer-friendly information even available for people to make these types of decisions-- if the decisions are easy to make, why do employer-oriented health care consultants flourish? These are not trivial questions. Evidence is accumulating which may provide answers.

Many Americans show an increasing resistance to employer, government or provider paternalism and, perhaps not incidentally, an increase in health care consumerism. To these employees it appears to be a matter of control. The KPMG study showed that while 45% of employers thought their employees wouldn't be interested in a defined contribution plan, in fact 73% of the employees were. Profiles of "interested" employees showed them to be more dissatisfied with their current plan and also much more experienced with the health care system than those who didn't want the new system. Similarly, only 16% of the interested employees compared to 40% of the non-interested employees thought their employer was a trustworthy source for plan selection.

Employers felt their current health plan benefits were a value to the company as both a recruitment tool (39%) and in providing employee satisfaction (38%). They felt current defined benefit plans are a means of attracting and keeping employees although 49% said they would change current coverage to achieve better cost control while 23% said they would change to achieve greater choice of plans, or more satisfied employees (19%). Only 16% of employers said they would change current coverage to achieve greater quality of health care. This last finding may speak to the question of how poorly equipped employers may feel to evaluate health plans other than in an economic sense.

The KPMG study further illustrated that among employers interested in the new idea labor agreements and government were seen as major barriers to implementation, whereas non-interested employers saw employee education and employee acceptance as major barriers. Again, these findings indicate a strong paternalism on the part of many employers and may indicate that while they say employees wouldn't accept the new ideas, in fact, they may not fully trust employees to make the right decisions.

The reviewed literature universally comments on the importance of employer tax incentives in maintaining either defined benefits or contributions. A second common concern revolves around state insurance regulations regarding the pooling of risk and the increased costs usually associated with smaller groups of enrollees. Estimates of increases in the costs to purchase comparable insurance on the individual insurance market rather than the employer "group" market range from 24-32%6. The idea of pooling employees from many small employers to reduce coverage costs may remain a hot topic regardless of benefit payment plan.

Implications:

In the authors’ view, at least four events must occur before the defined contribution health care benefit option will become wide spread. One, the new plans must provide the same tax incentives to employers as the old. Two, insurance regulations must be adjusted to allow group pricing with individual purchasing. Three, employers must work through complex cost-subsidies questions so as to ensure all employees (regardless of age and health status) are treated equitably and given a reasonable amount of funds with which to purchase coverage. Four, until researchers and olicy-makers agree upon and implement a technical quality measure of health outcomes consumers will be no more able than employers to select quality or high value health care providers.


1While a majority of the survey results presented here are from a KPMG Peat Marwick, May 2000 published study, a large literature on this subject exists. The interested reader might begin their research at www.mcol.com, which offers a good overview and reasonably comprehensive bibliography.

2Employee Retirement, Income and Security Act (l974)

3Lave, J.R. et al, "Changing the Em ployer-Sponsored Health Plan Sys tem…." Health Affairs, Vol. 18, No. 4 (July/August 1999)

4Fronstin, Paul, "Employment-Based Health Insurance Remains Popular," employee Benefit Research Institute News Brief, (April 29, 1999)

5Preferred Provider Organization, Health Maintenance Organization, Point Of Service

6Employee Benefit Research Institute, May, 2000.