Defined Contribution Health Plans Start To Make Some Headway

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Defined contribution health plans are starting to show up in the real world.

Even benefits experts who are counting on the plans to save the U.S. private health finance system say most are too new to supply meaningful performance statistics.

But employers that have tested the defined contribution plans say so far, so good.

At RD Systems, a South Beloit, Ill., production automation company with fewer than 50 employees, adopting a defined contribution plan a year ago “has made a huge change in the way [employees] use insurance,” says Ness Sebeck, the human resources director. “If someone has a cold, they dont run to the doctor to get overmedicated. And weve seen fewer sick days, shorter sick periods and less absenteeism.”

Nanophase Technologies Corp., Romeoville, Ill., a manufacturer of nanocrystalline materials, began using a defined contribution plan Jan. 1.

“Now people are a lot more interested in their personal medical fund and how that money is spent,” says Nancy Baldwin, Nanophases HR director.

Employers are shifting to defined contribution plans, which are also known as “consumer-driven” or “consumer-directed” plans, in an effort to give employees an incentive to do a better job of shopping for health care.

The typical DC health plan combines employer-funded health reimbursement accounts with health insurance that has a deductible of at least $500.

The reimbursement accounts cover only part of the deductible, to discourage employers from seeking unnecessary care or using overpriced providers.

Many of the plans also try to give members information they can use to become better health care consumers.

The Internal Revenue Service gave the companies organizing and sponsoring the DC plans a big boost earlier this year, by ruling that employees can keep unused reimbursement account assets in the accounts at the end of the year without treating the assets as taxable income.

The IRS also ruled that sponsors can use systems based on debit cards, stored-value cards and the Web to supply some of the documentation necessary to show that employees are spending account assets on eligible expenses.

Companies with defined contribution products already on the market include Aetna Inc., Hartford, and a host of smaller players, and many more companies say they are adding defined contribution plans in time for the fall enrollment season.

A recent survey by Hewitt Associates L.L.C., Lincolnshire, Ill., found that 46% of surveyed employers were interested in offering defined contribution health coverage.

Tom Beauregard, a Hewitt consultant, says that within three years DC plans will cover more than 20% of the insured employee population.

Paul Fronstin, director of health research and education at the Employee Benefit Research Institute, Washington, estimates that fewer than 200 large employers offer the plans and that fewer than a million workers are eligible to join the plans.

He also estimates, however, that the number of plans has doubled since 2002.

When Towers Perrin, New York, surveyed Fortune 100 companies recently, it found that 15 now offer defined contribution plans to a total of 500,000 employees and that at least 10 more Fortune 100 companies are thinking about adding defined contribution plans in 2004.

Although more employers are looking at the defined contribution concept, “the number that launch it is still fairly small,” says Michael Taylor, a principal with Towers Perrin.

Aetna reports that 73 companies have signed up for its defined contribution program and that the program will cover more than 40,000 employees and dependents.

Experts point out that most employers offer defined contribution plans as alternatives to traditional plans rather than as replacements.

Aetna, for example, has found that only two of its DC plan customers actually are replacing existing, traditional health plans with defined contribution plans, reports Robin Downey, Aetnas director of health research and education programs.

One of the employers replacing a traditional plan is large, and one has about 300 employees, Downey says.

“We think, over time, more employers will offer [DC plans] as a full replacement,” Downey says.

Taylor and Beauregard, the benefits consultants, predict the number of employers using DC plans as replacement plans will grow slowly.

“Benefit managers are still cautious about blowing up their existing health care plan,” Taylor says. “Its much more likely theyre going to continue offering a choice.”

Beauregard expects employers to use pricing and education to steer employees into the new plans, just as they used those tactics to persuade employees to try managed care plans.

“I think we will see more full replacement in the small employer market, because [smaller employers] dont have the same employee relations or public relations concerns” that larger employers have, Beauregard asserts.

Today, when employees at a typical employer have a choice between a DC plan and traditional coverage, somewhere between 3% and 18% choose the defined contribution plan, Fronstin says.

One possible challenge for employers that offer a choice of plan designs is adverse selection. Some experts fear that the defined contribution plans will appeal mainly to healthy employees who want lower out-of-pocket costs, while sicker beneficiaries will stick with more traditional plans, driving up the traditional plans costs.

At Aetna, adverse selection has not been a problem, Downey says.

“In some plans you see a more favorable selection of employees taking the defined contribution plan, but not necessarily,” Downey says. “Its like any other type of plan. It depends on how you structure your contribution and how it compares to what else is available.”

Downey also finds that the demographics of defined contribution plan members are similar to those of the traditional plan members.

“Families with children are just as likely to take [defined contribution coverage] as other groups,” he says. “Its not young single people only.”

The fact that the defined contribution plans usually compete head to head with employers traditional plans helps test the popularity of the DC approach.

Most employees who sign up for defined contribution coverage seem to like it, Fronstin says. “From what Ive heard, some of plans report a 97% reenrollment rate,” he reports.

When Aetna surveyed 400 defined contribution plan members, the results were positive, Downey says.

“Members thought they were making better informed decisions and that they were better health care consumers,” Downey adds.

When employees do choose defined contribution plans, employers often see big savings, according to Ken Linde, chairman of the Consumer Directed Health Care Association, Oak Ridge, Ill.

Employers that buy defined contribution coverage are paying 15% to 25% less than they would be paying for comparable coverage from a preferred provider organization without the same kinds of member incentives, Linde maintains.

Many defined contribution plan companies “are selling to small to midsized employers that find they cant afford HMOs and PPOs,” says Linde, who is president of Destiny Health Plans Inc., Oak Brook, Ill., one of the companies in the defined contribution market.

Employers are hoping defined contribution plans lead to lasting improvements in care cost and service.

RD Systems, for example, switched to a defined contribution plan after rates for its previous, traditional carrier “went through the ceiling,” Sebeck says.

Even after RD Systems collected 25 quotes from a dozen brokers, the company faced the prospect of an 18% to 20% cost increase.

But the company now supplying RD Systems defined contribution plan quoted a rate for 2002 that was only 10% higher than the 2001 rate.

RD Systems still pays an average of 70% of employees health care costs.

Employees get a personal medical fund of $1,000. After thats exhausted, depending on the plan chosen, the employee may pay $300 to $750 out of pocket, after which the plan pays 90% of costs.

The surgical deductible is $250, Sebeck says.

The plan has not discouraged employees from seeking necessary medical care, “but it has made a huge change in the way they use insurance,” Sebeck reports.

Baldwin, the HR director at Nanophase, agrees that adopting a DC approach amounts to an attempt to change employees health care buying behavior.

Nanophase completely replaced its existing health plans after it learned it would have seen cost increases of 17% to 20%, Baldwin says.

“I dont think people were at all aware of medical costs” under the previous plan,” she says.

Nanophase funds employees medical fund at $600 for individuals, $1,050 for couples and $1,500 for families with children.

Advocates for DC plans argue that they make it possible for hard-pressed employers to continue offering health benefits at a reasonable cost to employees.

“Without plans like this, employees would have to accept 20% to 30% contribution increases annually for traditional plans, based on trends and employers need to share more costs, ” Taylor says.

As for consumers out-of-pocket health care expenditures, “its not an easy answer whether the cost will go up,” Taylor says. “There are clear winners and losers in early plan designs, but, if you do it carefully, you can at least minimize the losers.”


Reproduced from National Underwriter Life & Health/Financial Services Edition, June 30, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.