More Choice, More Voice

Defined Contributions Could Redefine Health Care Financing

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Medical Economics Feature -- August 2000  

By Laurie Stoneham  

The way you practice medicine in the coming years is probably going to change. We're not talking minor stuff here. Big shifts are under way in the mechanisms for financing health care in this country.

And that's exquisitely good news for physicians. Or is it?

What's being discussed everywhere from boardrooms to think tanks to the American Medical Association House of Delegates is a fundamental change in the way health insurance is purchased. Under the current system, employers pay for most of the health insurance in this country, footing the tab for some 160 million Americans.

While large companies may offer several plan options, employee choices are usually fairly limited. In a small company, if health insurance can be offered at all, employees generally have only one take-it-or-leave-it choice.

A new concept, called "defined contribution," could change all that. In simplest terms, it could do to health benefits what 401(k) plans have done to pension funding. The employer would give an employee a set amount of money each year for health coverage, and the worker would decide how to allocate those dollars, including choosing the specific type and plan of health insurance.

Defined contribution is a concept still in its infancy as employers examine whether it truly is the answer to their rising employee health insurance costs. Its use is not yet widespread. Versions of the concept are being used by some employers such as Xerox and by some state governments.

"It basically gets employers out of the health care business and back into the check-writing business," said John Goodman, PhD, president of the National Center for Policy Analysis (NCPA), a Dallas-based think tank, and an adviser to Gov George W. Bush's presidential campaign.

The drivers  

What's all the hullabaloo about? Basically, employers are as disenchanted with health insurance as physicians are, maybe more so, because they consider it none of their business.

Companies aren't in business to buy health insurance; they're in business to make money delivering a product or service. And rising health care costs are once again eating away at profits and affecting their competitiveness in the world marketplace.

Greg Scandlen, also with NCPA, is a nationally recognized expert in this area. He explains that before the days of COBRA and managed care, health benefits were easy for employers to offer and administer.

"Hiring a new person costs, say, $45,000 -- $40,000 in salary and $5,000 in health insurance. It used to be that employers were indifferent to health insurance matters because it was easy to administer. Now, that $5,000 that's going into health care is a super hassle. The rules, regulations, and reporting make it a lot tougher than paying wages," Mr Scandlen said.

Defined contributions could offer a way to shield companies from increasing costs, administrative hassles, and grief by empowering the health care consumer -- the employee -- to become more engaged in the decision-making process of choosing a plan that meets his or her individual needs.

And employees aren't all that happy about having minimal input about something as important as their own health and welfare. "Employees are growing increasingly dissatisfied with a paternalistic system in which they have little or no say in how this large part of their pay is spent," said Grace-Marie Arnett, president of the Galen Institute in Alexandria, Va, a public policy research organization specializing in free-market health reform ideas. Several surveys have shown that employees are more satisfied when they are given a choice, even about managed care, she says.

"As more options become available to obtain health insurance through other organizations, they will demand more control over how these dollars are spent so they get coverage that suits their particular needs," Ms Arnett said.

Mr Scandlen added, "It's not a particularly radical idea to allow individuals to have control over their financial resources."

Some perspective  

The existing tax laws regarding health insurance have been around since World War II, when health benefits were introduced as a tool for recruiting workers. In the 1950s, health insurance became a major tax deduction for employers. They could provide insurance for their employees without paying payroll taxes or withholding income taxes on that money. Similarly, it is non-taxed income for the employee.

George Fisher, MD, author of The Hospitals That Ate Chicago and an AMA delegate from Pennsylvania, says that's the biggest pot of non-taxed money in the country. According to the Lewin Group, a health care research organization, $356 billion currently goes into health benefits, which costs state and federal governments $140 billion in foregone taxes.

Of course, along with the tax benefits, employers have a business interest in maintaining a healthy workforce -- it reduces sick leave, increases productivity, and improves morale.

But increasingly, employers want to get back to their so-called "core competencies," says Donna Kinney, manager of regulatory analysis and advocacy for the Texas Medical Association. They want to spend their time and energy and resources doing what they do best, not messing with the no-win grumbling of employees and dealing with the frustrations of health insurance.

Basic disconnects  

Most experts say health care is the only segment of the economy where consumers have no idea -- or interest -- in the true cost of the services they're using. Therefore, they have no responsibility or accountability in using those services.

This disconnect destroys the basic buyer-seller relationship. Mr Scandlen points out that the normal purchasing incentives and motivations are turned upside down, because consumption decisions and payment choices are divorced. "With managed care, the doctor is caught in the middle with a patient saying, 'I don't care what it costs, I'm covered,' and the health plan saying, 'We aren't going to pay for it.'"

Then there's the business of perception. Dr Fisher calls it the "moral hazard of insurance." Because it seems to be fully free, the consumer feels no responsibility to use resources wisely.

This entitlement mentality is the very essence of the problem, according to Paul Handel, MD, a Houston urologist and chair of TMA's Council on Socioeconomics. "Until there is a major overhaul of the tax laws in this country, employees have no role in the decision-making process and will continue to view health care as a benefit of employment that they are entitled to receive for free."

Relationship problems  

Dr Fisher believes every physician in the country is "sick and tired of being constrained by the problems imposed by managed care. There is constant wrangling in the office that occurs over insurance matters that neither the physician nor the patient has had anything to say about. It has chafed and warped the patient-physician relationship."

With defined contributions, employees would choose their own health plan. They not only would be more satisfied but also would tend to adhere to the plan's rules and procedures, Dr Fisher feels. "Those who didn't choose tend to chisel at the rules, so neither the physician nor the patient has any allegiance to the plans or the parameters of those plans."

Dr Goodman says defined contributions should allow the kind of insurance that permits both physicians and patients to establish long-term relationships. He characterizes this as "personal and portable insurance that's owned by employees and travels with them from job to job. An ongoing relationship with an insurance company leads to a long-term relationship with a physician. There will be continuity of care that's not interrupted every time something happens in the labor market," he said.

How it might work  

The actual implementation of a defined contribution system might follow the 401(k) model, wherein the employer chooses a third-party trust company, Mr Scandlen envisions. "This organization would offer essentially a health marketplace for employees. The employer would turn over the contribution to this trust, and the employee would then determine how those funds are to be spent. It would be very much like how mutual funds and other financial products are selected for 401(k) accounts."

Medical savings accounts (MSAs) may be a vehicle for how defined contribution funds are managed by employees. Essentially, this method allows employees to choose a lower-price premium plan that requires a high deductible. The premium savings are then put into an interest-bearing account and the money can be used for other health care services, such as dental coverage.

Ms Kinney points out that using MSAs would require a change in federal tax laws because the existing code allows only small employers -- those with 50 or fewer employees -- to offer MSAs as tax-free benefits.

Potential benefits  

The experts agree that a defined contribution system would allow both employees and employers to enjoy the advantages of providing tax-free, employer-subsidized insurance, without the disadvantages and additional costs of individual coverage. According to the experts interviewed for this article, other features and benefits of the system would include the following:

  • Physicians could help educate and empower their patients to choose better plans.
  • Employers would be relieved of the regulatory and reporting hassles.
  • Health maintenance organizations (HMOs) and managed care plans would not be eliminated, but employees and physicians could choose not to participate in them.
  • Physicians would have more direct and deliberate relationships with their patients. Individual patients would have a choice of physicians as well as plans under this system, thereby ensuring continuity of care.
  • Physicians would have greater leeway in pricing their services with more market-driven autonomy.
  • Cost-consciousness would evolve into cost-competitiveness. As with other purchasing decisions, if a person wants to save money on a particular service, he or she could do so by sacrificing convenience or some other factor.

The kinks  

Probably the biggest bugaboo in this whole concept has to do with how employees will be pooled. Will they be buying group or individual insurance? If it's group insurance, what is the risk-pooling mechanism? How would the system work with sicker patients who need more health care services?

Ms Arnett suggests a number of ways individuals could buy group insurance outside an employer grouping. These might include labor or professional organizations, or even religious groups.

The other major concern, experts note, is teaching employees how to evaluate and compare the benefits offered by numerous health plans. Everyone agrees that this system would rely on Internet technology, which, at this point, is the only feasible way to store, manage, distribute, and administer the vast amount of information regarding the various plan benefits.

Until earlier this year, it was assumed that the tax code would have to be changed to make defined contributions viable. However, a 1961 IRS ruling (Rev Ruling 61-146) has shown that employees can retain tax exclusion in a defined contribution environment.

In November 1999, a KPMG survey of 14,000 employees and 103 executives of Fortune 1000 companies found that 46% of the executives were receptive to the concept of defined contributions. Of the receptive executives, 80% indicated they would implement it within 2 years if there were no tax disadvantages.

The reason the defined contribution system has not been implemented heretofore, Mr Scandlen believes, has to do with regulatory confusion and the misunderstandings regarding the tax code. Also, he thinks employers "feel an obligation to protect their high-risk employees."

In an article published earlier this year on the Defined Care Web site, a service of Managed Care Online, Peter R. Kongstvedt, MD, of Ernst & Young, LLP, said the trend toward defined contributions is not as big as some people believe. "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," he wrote.

Dr Kongstvedt cautioned that pundits who say defined contributions are the wave of the future might be wrong. As evidence that forecasts about health care and health insurance are often wrong, he cited rosy predictions about the future of staff model HMOs, capitation, vertically integrated health care systems, direct contracting by employers, and practice management companies.

Factors that may inhibit the broad acceptance of defined contributions, he said in the article, include:

  • Health insurance cannot be compared with retirement plans because employees do not expect to be at the same job all their lives. Workers don't wait until they're 65 to use their health insurance, thus portability is important.
  • Choice and control is desirable, but "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."
  • A tight labor market might inhibit the growth of the defined contribution system. "In the case of small employers, the choice is often between defined contributions and no coverage at all," he wrote. "In larger companies that must compete for employees, health benefits are second only to wage and salary. So if you make that change, you will be at a disadvantage in attracting the workforce. With unemployment in early 2000 sitting at an incredible 4.2%, it's a seller's market."

Physician challenges  

Health care would become more competitive under such a system, proponents contend. Not only would health plans become accountable to consumers who can put their money behind their complaints, but physicians would also need to be more service conscious.

"This will force physicians to compete and distinguish themselves in the marketplace," said Ms Arnett.

And just as patients can choose not to support plans they feel are not cost effective, the same will be true for physician services. She added, "Patients, not just health plans, will have something to say about whether a particular procedure or test has value."

The outlook  

According to Ms Arnett, the bottom line is, "Whoever controls the dollars, controls the decisions. It can be governments, company human resources directors, health plans, or patients. Those are the choices the industry is facing."

While acknowledging it as a step in the right direction, Dr Handel believes the defined contribution concept is essentially a Band-Aid. "Looking at the big picture, it's an attempt to fix the system without significantly changing it. For some 50 years, employers have been paying for health care and taking the tax benefit for it. Until employees enjoy the tax benefit and are given more control over how the money is spent, all we're doing is rearranging the deck chairs on the Titanic," he said, "because right now, defined contribution does nothing to address the fundamental demand problems and double-digit inflation in premium costs."

Dr Handel believes defined contributions "will make employees wiser purchasers and users of medical care and will motivate them toward healthier, preventive lifestyles because they will begin to understand the cost of health care."

Dr Fisher notes that defined contribution is not a term physicians know or understand. "But I'd like them to salute when they hear it," he said.

"I want them to be careful of what they're saluting," interjected Dr Goodman. "If it's personal and portable, that's good. But if you're talking about managed competition, like federal and some state employees who can choose from a number of health plans every 12 months, that's not where we want to go. So the details do matter."

"No change like this happens rapidly," Dr Fisher said. He sees its implementation some years down the road.

Dr Goodman disagrees. He declined to name them, but he said major stakeholders in the heath insurance industry in Texas are very interested in this concept, and he sees it being addressed in the next session of the legislature.

"Physicians are going to have to become better communicators and educators. With education and communication, physicians and patients will be able to make better decisions in terms of health care. But the defined contribution system is not the end process, it's only an evolutionary step," he said.

"If they want to take my word for it, it's a good thing," Dr Fisher offered . "I see very few disadvantages to physicians and none for employers or employees."

Laurie Stoneham is a freelance writer in Austin.  

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