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Why defined-contribution health-care benefits is a bad idea whose time hasn't come.
David M. Katz, CFO.com | US
March 1, 2001
On the surface, cloning defined-contribution benefits for use in health care has a powerful appeal for CFOs.
Plunk down a set amount of health-care dollars in an account for your employees each year, and let them spend it on whatever health plan they choose, rolling over the surplus from year to year. Think 401(k) matching.
Just like that, you've shed the risk of a spike in health-care costs, the yearly haggling with insurers and managed-care outfits, and the chance of being pulled into a malpractice suit.
Sound too good to be true? It is.
Currently, consultants and software makers are pushing the idea as The Next Big Thing in health benefits, following the failure of managed care to curb costs. But strip away the sales hype, and you have an idea that's impractical on many counts.
One big problem is that you'd have to allot cash perhaps double the worth of the premiums paid for group health insurance if you send employees out into a free market. The market advantage of buying health insurance in groups would vanish.
Now, some say a free market would be the strong medicine needed to significantly slash health-care costs. Maybe so.
But for that to work, a wide-scale employer exodus from providing health benefits would have to be orchestrated. After all, what employer would want first-mover advantage in such a scenario?
First off, your tax situation would become iffy. Currently, there's no tax break to an employer who simply pays cash directly to an employee for benefits, although self-employed people can use their own savings to set up a tax-deferred Medical Savings Account, similar to an IRA.
In changing over to a defined-contribution approach, an employer risks unraveling strong tax advantages for both itself and its employees. Under the current system, of course, an employer gets a current deduction for the health insurance premiums it pays, and neither employer-paid premiums nor insurer-paid claims are included in an employee's taxable income.
The fact that both employers and employees get tax advantages is a notable exception to the "matching rule" of compensation taxation, according to Alden J. Bianchi, a partner in Mirick, O'Connell, DeMallie & Lougee, in Worcester, Mass. Under the rule, if an employer or employee gets a deduction, the other party commonly has to pay the tax.
Further, Bianchi notes, unlike pensions, for which employees must pay taxes when the money is distributed, health benefits are never taxed. "The tax cost [of the health-benefits exemptions] to the Treasury is substantial," he adds.
To depart from such a potent subsidy without a sure payback should be an unacceptable peril to most employers.
Further, if you're the first to offer defined medical benefits to your employees with anything less than a huge cash allotment to cover their purchase of insurance, your workers would eventually see it for the big cutback it is. In today's tight job market—or any relatively competitive market—good workers in droves will swarm to your competitors.
Another problem with the idea is that, while it sheds an employer's liability in providing the benefits, it's likely to pick up liabilities associated with not being involved in benefits.
Let's say an employee, armed with new defined-contribution dollars and in quest of a low-cost provider, visits a quack and gets badly misdiagnosed. Who's going to get sued besides the doctor? Probably the company providing the benefit.
This suggests another fly in the defined-contribution ointment: too much employee choice. While the word paternalistic has gotten a bad name, the presence of paternal restrictions on provider choice keeps patients away from quacks. For many ailments, many people simply don't know enough to find the correct specialist.
Employers do have an interest in maintaining a healthy workplace, and the Darwinism of a free-choice system could be self-defeating in that respect.
For all these reasons, senior financial executives would do better to spend time on other things than hatching a defined-contribution scheme for health benefits.