Defined Contribution Health Insurance
Table of Contents
"For more than 50 years, employers have been the main providers of health insurance coverage."
Many employers are concluding that it is time to rethink the way they provide health insurance benefits for their employees.
For more than 50 years, employers have been the main providers of health insurance coverage for Americans. There have been dramatic changes during those years. Fifty years ago, only half of all Americans had any health insurance coverage, and most of that was hospital indemnity coverage that provided a fixed dollar payment for a certain number of days in a hospital.1
"In 1960, more than half of the health care dollars were spent out of pocket."
Through the 1950s and 1960s, employer-based coverage grew in both numbers of people covered and richness of benefits. By 1965, 72.5% of the population was covered by some form of private health insurance, with half (50.3%) of these covered by "major medical" plans - double the percentage just five years earlier (26% in 1960).2
Despite the growth in employer-sponsored coverage, most health care spending continued to be paid out of pocket. As Figure I shows, in 1960, out of total health care spending of $23.6 billion, $13.1 billion (55.5%) was paid out of pocket, $5.4 billion (22.9%) by private third-party payers, $3 billion (12.7%) by state and local government, and only $2.1 billion (8.9%) by the federal government.3
"The percentage of out-of-pocket health care spending has shrunk dramatically since the creation of Medicare and Medicaid."
This changed dramatically after the creation of Medicare and Medicaid. By 1980, as shown in Figure II, total health care spending reached $217.0 billion, with only 27.8% out-of-pocket. Private third party payers picked up 32.1% and the federal government paid 29.2%.4
These trends have continued. In 1998, with total health care spending of $1,019.3 billion, the federal government was paying for more than a third (33.7%), as Figure III shows. Out-of-pocket spending diminished to 19.6% of the total, and third party payments grew to 36.8%.5
Not surprisingly, the flood of new federal money and the decrease in out-of-pocket spending resulted in health care inflation and an increasing share of national income going to health care after 1965. As a percentage of Gross National Product, health care spending increased from 4.6% in 1950 and 1955 to 5.2% in 1960, 5.9% in 1965, 7.2% in 1970 and 8.3% in 1975.6
In response to this alarming growth, the federal government imposed a series of new laws and regulations intended to slow health care inflation:
"The flood of new federal money and the decrease in out-of-pocket spending resulted in health care inflation and an increasing share of national income going to health care."
- President Nixon imposed wage and price controls in August 1971. The controls were lifted for most of the economy in January 1973 but retained for health care until April 30, 1974.7
- Legislation creating Professional Standards Review Organizations for Medicare was enacted in 1972. This law was intended to supervise physician practice to ensure appropriate treatments and lengths of stay and to restrain costs.8
- The Federal HMO Act of 1973 provided seed money for HMOs that met certain federal standards, and exempted these HMOs from state regulation. It also included a "dual choice" provision that required employers with more than 25 employees to offer an HMO option.9
- The National Health Planning and Resources Development Act of 1974 created an elaborate health planning system aimed at controlling the growth of hospitals and other health care facilities.10
- Also, the Employment Retiree Income Security Act (ERISA) was enacted in 1974. ERISA enabled employers to escape state regulation by self-insuring their health benefits.
Despite all these efforts, health care costs continued to rise. Every year from 1965 through 1982, the nation endured increases in health care spending in excess of 10%, reaching 14.5% in 1975 and 1976, 14.9% in 1980 and 15.9% in 1981 [see Figure IV].
In the early 1980s, many large employers switched to self-insurance under ERISA to better control their health care spending. At that time of high inflation and high interest rates, many employers did not believe insurance companies were doing enough to restrain spending. One executive told Congress, "When we were insured, the insurer got a percentage of the claims paid. They had no interest in holding down costs."11
Employers instituted a number of cost-containing efforts, including benefit redesign emphasizing outpatient care over inpatient treatment and programs such as second surgical opinions and preadmission certification. They also increased benefits for substance abuse treatment, hospice and home health services. These programs had remarkable, if temporary, success. One author wrote, "Inpatient days dropped from 278 million in 1981 to 220 million by the end of the decade... outpatient visits increased from 203 million in 1981 to 300 million by 1990."12 Former Secretary of HEW (Health, Education and Welfare, now Health and Human Services) Joseph Califano had gone to work at the Chrysler Corporation and concluded the private sector could do cost containment far better than the government. He wrote:
My conviction that the key to health care cost containment rests in an aroused private sector in no small measure relates to the contrast between the frustration of trying to get government to deal with this problem and my recent experience with Chrysler Corporation. In 1984, Chrysler cut its health care bill to $402 million, down by $58 million from the $460 million projected in our budget."13
"Managed care has had success in holding down cost increases, but at a high price in employee morale and community relations."
Mr. Califano had a lot to crow about when he was writing in 1986. For five years in a row (1982-86) the rate of increase in total national health care spending had dropped. He wasn't alone. Margaret Heckler, Secretary of HHS under President Reagan, famously said in 1985 that we had "broken the back of the health care inflation monster."14
But soon enough, health care inflation was back, growing every year for four years until it reached 15% in 1990. Employers had succeeded in holding down costs for a time, but now they needed another strategy. They switched to managed care in massive numbers. From 1984 to 1990, HMOs and PPOs increased their share of the private benefits market from 7% to 34%, and they continued to grow through the 1990s, capturing 65% of the market in 1995.15 More recent estimates place managed care's market share at 85%.16
The hope for managed care was that it would provide first-rate health care while restraining utilization and cost. Managed care was supposed to provide incentives to keep people healthy so they would consume fewer health care services. It was supposed to help patients bond with their primary care provider who would direct them to the most cost-effective services. It was supposed to educate patients to take better care of themselves and avoid expensive professional care for ordinary ailments. It was supposed to bring a new businesslike attitude to health care services.
In fact, managed care organizations (MCOs) have had success in holding down cost increases, but at a high price in employee morale and community relations. Cost increases may have flattened, but the reasons aren't clear. It may be that MCOs have reduced waste and increased efficiency. Or it may be because that MCOs have denied needed services; or have selected healthier customers; or have underpriced their premium to gain market share; or have provided lower-quality care and service; or have cajoled doctors into providing cheaper - not better - care. Academic research on these issues has been mixed.17
Most likely, the causes for the reduction in cost increases are a complex mix of many factors, but there is little evidence that managed care has lowered costs by improving patient health or by preventing disease. There is little evidence that MCO patients are better educated or better able to avoid needless care. There is little evidence that MCOs are more efficient at delivering care.18
But there is plenty of evidence that patients and doctors are disgruntled. They resent externally imposed controls, and fear that needed services are being denied.19 More importantly, employees object to being placed in a plan without their consent. Research indicates that people who choose managed care are usually happy with their choice. It is the people who have no choice who are the least happy.20 Eighty-three percent of employers offer no choice of health plan at all and the remainder usually provide a choice of only two or three plans.21