Risk Management

Defined-Contribution Plans: the Next Big Thing after Managed Care?

How to get employees to spend less on doctors.
David KatzSeptember 28, 2001

With managed care apparently dead as a cost-containment tool, what can employers do to stop the steep rise of their health-benefit expenses?

For a long time, CFOs could delegate such worries to their human resources people, confident that HR could use managed care to curb medical inflation.

But with health care’s emergence as one of the most sharply rising costs in a time of low inflation, however, senior financial executives are likely to become concerned.

What may be worse than the cost hikes, however, is the failure of managed care to curb costs.

On the heels of years of double-digit premium hikes, health maintenance organizations, those classic forms of managed care, are typically asking employers now for 20 percent increases in their January 1, 2002 premium renewals, and 50 percent rises aren’t uncommon, says William M. Mercer, the benefits consulting firm. For more on why HMOs aren’t working, click here.

Employers have thus been searching for a new cost-containment model to replace traditional managed care. The idea that some companies, prompted by consultants, have come up with is an import from the pension arena: the defined-contribution approach.

At first, the notion was crudely conceived. As you would with a 401 (k) plan, simply plunk down a set amount of cash into an annual account to be used by employees to pay health care costs. Thus, workers would have to pay their doctor bills out of their own pockets, as it were, and feel the cost pain their employers’ have long felt.

Employees are bound to spend less if they spend their own money, the theory goes. The problem, however, has been that employees’ health could suffer if, motivated solely by cost, they made bad decisions. Employers could then feel the brunt of those choices in bad employee relations and, worse, lawsuits. For another column on defined-contribution health benefits, click here.

Now, however, some employers are experimenting with a more clearly defined form of the approach that seems to protect employees a bit more. Since “defined contribution” already has gotten a bad name, consultants are calling it “self-directed” or “consumer-driven” health care.

While the plans vary, they essentially involve an employer setting aside a yearly amount of money that employees can draw on to buy health services and prescription drugs. Employees manage the money, termed a “personal care account” (PCA) by one small plan administrator, as they choose. The plans tend to include four elements:

  • Full reimbursement for basic preventive medicine when done through a network of providers. This includes payment for services like prostate-cancer screening, well-baby care, and physical exams.
  • A PCA, which pays for traditional health care, including doctor visits, and a host of non-traditional ones, like lead-based-paint removal. The employer holds accounts of, for instance, $1,000 for an individual and $1,500 for a family, in trust.

    A key PCA feature is that employees can roll over unused dollars into their accounts for the next year, when they might use them for a new pair of glasses, for instance, or a dental cleaning.

    Proponents say that since dollars can be carried over from year to year but aren’t portable when workers change jobs, the accounts can serve as good retention tools.

    At the same time, employers can pick up the interest earned on the accounts, says Chris Delaney, marketing vice president of Definity Health, a Minneapolis-based third-party administrator that develops such programs.

  • A gap, or “high deductible,” of say, $1,500 to as much as $2,500, paid completely by the employee. PCA outlays for many traditional expenses, including doctor visits, however, can count toward the deductible. Further, employees can use PCA rollover dollars from prior years to fund costs that aren’t covered.
  • Unlimited, in-network catastrophic coverage for costs above the gap. Employers are likely to set a limit of say, $6,000, for care provided outside of a designated preferred provider network, thereby injecting an element of managed care into the plan.

In January, Aon Corp. and Medtronic, Inc. launched defined- contribution plans developed by Definity. In about two weeks from now, two East Coast Fortune 150 companies will also launch Definity Programs, says Delaney, who didn’t want to name them.

Tony Kotin, a principal and health care consultant in William M. Mercer’s Chicago office, says he knows of about 10 Fortune 500 companies set to launch defined-contribution pilot programs among selected groups of employees.

Tom Lerche, a senior vice president with Aon Consulting, in Chicago who has introduced some companies—including parent Aon Corp.—to the concept, and uses it for his own health care, thinks it’s become especially attractive during the current economic slowdown.

“Employers are in financial pain, and the [HMO premium] increases are coming at a time when employers aren’t able to sustain them,” he adds.

Lerche thinks the idea could really catch fire if one or more big insurance companies become interested in offering plans built around it. Currently, a handful of small plan administrators like Definity and Alexandria, Va.-based Lumenos offer it.

While current plans do cover preventive and catastrophic care, they still represent a greater risk to employee health than other health plans do. They contain a strong incentive for employees to save money— and maybe imperil their health—by not going to the doctor.

Further, although the plans tend to offer employees a wealth of online information, that may not enable a person without a medical degree to make a truly informed medical choice.

“It does require the employee to think long and hard about if they need a particular kind of care,” says Aon’s Lerche.

“There is a concern with how well the individual can manage [his or her] care when faced with an array of incentives,” he says, adding that it’s “too soon to know” whether such plans present a substantial risk to employee health.

For now, though providers argue that the plans can attract people of varying ages, the notion seems most appealing to young, healthy people, who can bank on carrying over dollars they can use to get new contact lenses or catch up on their dental hygiene. In contrast, high users of health care won’t want such limits placed on their coverage.

Aon’s Lerche thinks it’s risk takers, “people who enjoy a high degree of autonomy, who like to choose their doctors” that are most attracted to the plans.

Still, the plans represent an advance in making practical use of an idea with potentially widespread appeal among employers. Some day soon, defined contribution may well become the replacement for managed care.