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There has been considerable discussion about the movement from defined benefit health insurance/benefits to defined contribution. In defined benefit plans, employers offer a health plan where the benefits are defined and the employer pays much of the cost, but the employee has limited options about what they can choose (e.g., they might be able to pick from a high option, a low option, an HMO, etc.; but they can’t go out and get whatever they feel like getting).
Defined contribution means the employer gives the employee a fixed amount of money to pay for insurance, and it’s up to the employee to get it. If they want or need high benefits, they pay extra out of pocket. If they don’t need much, they can buy a cheaper health plan or perhaps use the money for something else. In many cases, the employer tries to get health plans to offer to employees under group rates, but that necessitates a limitation on the number of health plans being offered. There is a variation of this called a cafeteria plan.
Here are some talking points in the event that you find individuals who are convinced that defined contribution is going to take over the industry. There are several pundits who have said as much. For example, KPMG released a study that was designed by Regina Herzlinger (Harvard professor who was espousing the idea of “focused factories” a year or two ago) that says everyone wants this. Robert Blendon, another Harvard researcher has also said this is happening. The data show that there is indeed a movement towards this concept, but it’s confined to the small group market. As employer groups get larger, you see less and less of it.
There are a few reasons that are usually trotted out to support this notion. First, it is compared to what happened with pensions, where companies moved from defined benefits to simply contributing to a 401(k) or a similar pre-tax retirement vehicle. Second, everyone wants more choice and control, and this gives them that. And third, this allows the market forces to act, letting people buy the type of coverage that they want.
This trend is certainly real, but it is not nearly what the pundits say it is. The reasons for this will follow, but I do want to remind you that all pundits are wrong unless it is by chance (OK, there are one or two with good track records, but that doesn’t make up for the hundreds who basically turn over the magic eight ball). Don’t forget that it was the common punditry wisdom that we would all be in staff model HMOs by 1990 (oops). Then the entire health care system was going to be under capitation by 1995 (oops). Then the entire health care system was going to be in vertically integrated mega-health care corporations (oops and ouch too). Then provider systems/IDSs were going to contract directly with employers and cut out that nasty middleman (oops – forgot that Field of Dreams was not a documentary). Then the PPMCs were going to take over by controlling the docs (oops and goodbye Wall St.). I’ll stop there – you get the point.
First, you can’t really compare health insurance/benefits to pension. No longer does any employee expect to be at the same job for their entire life, and so portability is far more necessary than is a benefit that they’ll never receive because they’ve moved on. Health insurance, on the other hand, is not something that you wait until you’re 65 to use – you use it right now. Portability is clearly desirable, and allowed under HIPAA (but the cost can be a problem), but unlike pension benefits or a 401(k), health coverage is more than just a form of cash flow – it involves physicians, hospitals, drugs, etc.
Second, while the concept of choice and control is great, you have to compare it to what you can actually choose, not what you’d love to choose if you were sovereign of the universe. All markets need a willing seller as well as a willing buyer. Just giving someone money doesn’t necessarily mean that they can go out and buy what they want. For example, unless you are extraordinarily healthy, it is unlikely that you can go out and buy a first dollar, no-deductible fee-for-service plan that covers all health care needs (including drugs) with no utilization controls. And even if you found such a mythical thing (it never existed outside of certain union-negotiated contracts, and not many of them are left), you could never afford it. And if you have any real health needs, you just plain won’t get it.
There are some states that require guaranteed issue of health insurance, but the benefits are often constricted, and/or the cost is horrid. Under HIPAA, as well as COBRA, you can take your coverage with you, but you are not guaranteed the same cost forever. And even under HIPAA, you can’t just jump around from plan to plan – it’s much more restrictive than that. Lastly regarding states with guaranteed issue, they have found that the number of uninsured actually goes up, since healthy people don’t want to pay the high premium cost, while sick people sign up ASAP.
Third, this is a market that is still perverse, with a complicated system of tax subsidies, disconnects between who pays (employer), who decides on cost and volume (physician) and who gets the service (patient/member/employee or dependent). When people are exposed to the actual cost of insurance, they have far different answers to some of the questions about what they are willing to trade between cost and service. Of course, health status has a major impact on their opinion.
Other thoughts to consider include the tight labor market. In the case of small employers, the choice is often between defined contribution and no coverage at all. In larger companies that must compete for employees, health benefits are second only to wage & salary. So if you make that change, you will be at a disadvantage in attracting the work force. With unemployment in early 2000 sitting at an incredible 4.2%, it’s a seller’s market.
Most large employers are self-funded. If they go in the direction of defined contribution, they risk a change in the tax advantage of their benefit unless they switch to insured rather than self-funded under ERISA. Again, this will cause more or a problem in the work force than you might think, because there will be plenty of employees who won’t get what they want in an open insurance market. If they retain the risk, they have the identical problem of risk pooling, in that benefits money that goes into something other than health means less for health. In other words, if an employer retains the risk for health costs, they are going to have to pay more to make up for the money that the healthy employees put into something other than health.
The approach that’s been taken by large employers has been to have several choices available to employees, which is similar, but more constricted than an open market. Except it isn’t an open market, because a large employer is better able to negotiate with insurers or health plans for good rates and benefits, something that an individual cannot do (actually, it’s the benefits consulting firms that do this on behalf of the employers). The idea of purchasing pools does not fix this if anyone can opt out, since healthy people or groups will opt out to get cheaper rates, while sick people or groups remain in to try and get subsidized (by healthy people) rates; but as the healthy leave, the cost goes up until it is unbearable and becomes a guaranteed loss situation (called the “death spiral” by insurers). This is what happened in Florida and Oregon, when insurers slowly dropped out of these purchasing coalitions. The only coalitions that work are the ones that do underwriting, which again means that sick people pay more.
All consumer-focused free market forces push to disaggregate risk, while most regulatory, governmental and societal forces push to aggregate risk. If disaggregation of risk occurs too much, then the market will collapse for those who need it the most – sick people – since there won’t be enough money coming in from healthy people to cover the costs of the sick. That is not something that an employer, the government or society at large can tolerate.
So to make a wholesale movement to defined contribution work, you need to pass federal legislation that requires two things: mandatory participation so the healthy people won’t drop out, and guaranteed issue so that you can actually buy something. But you can’t mandate that insurers lose money, and the government doesn’t want to be in the insurance business. If you think a single payer system is in the works, remember Walter Mondale telling voters he’d raise their taxes (a career limiting statement if there ever was one); and anyway, we already have a single payer system – it’s called Medicare, and it’s less than ideal. Most working Americans want better coverage than that (e.g., Medicare doesn’t cover drugs, and the deductibles and copays area pretty high).
So remember Amara’s law (courtesy of Greg Lippe): In responding to change, we tend to over-react in the short run, and under-react in the long run. There is a movement in the direction of defined benefit, but it isn’t going to take over the industry any more than did staff model HMOs or capitation.
Reprinted with permission
Copyright 2000, Peter R.
Kongstvedt, M.D.
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